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A Monday Dozen [CHART PACK]

Be a disciplined rational investor. Follow logic and analysis rather than sales pitches, whims, or emotion. Assume you may have an edge only when you can make a rational affirmative case that withstands your attempts to tear it down. Don’t gamble unless you are highly confident you have the edge. As Buffett says, “Only swing at the fat pitches. ~ Ed Thorp

Good morning!

We’ve got decelerating global growth and falling earnings but flush liquidity, EMs turning a possible corner, their central banks pivoting hard, a potential EMFX long, and low recession probabilities + much more. Let’s jump in…

1) BofAML’s Global EPS model is predicting an ongoing earnings recession.

2) Global PMI and New Orders are now below 50 (contracting), global trade growth fell further in June, US ISM New Orders Index is “catching down” to the rest of the world, and DM PMIs continue to dip… (charts via MS)

3) Global Real GDP growth slowed sharply over the past year and looks set to continue to do so (chart via MS).

4) But liquidity (ie, financial conditions) remain very loose.

5) And this is interesting… EM manufacturing is outperforming DM for the first time in over 7-years (chart via HSBC).

6) After significant tightening last year, financial conditions in emerging markets are now starting to ease (chart via HSBC).

7) No doubt being helped along by a significant turn in EM monetary policy over the last 6-months (chart via HSBC).

8) Yet, fund flows into EM remain weak (chart via HSBC).

9) If EM is bottoming then I like the Mexican peso here (short USDMXN). It’s a technically nice looking setup. We may see a break lower this week, keep your eyes peeled.

10) Plus, MXN offers a LOT of positive carry right now.

11) The US Conference Board Employment Trend Index is starting to bleed (chart is month-over-month %). It’s not signaling that its time to sell your stocks, grab your children, and run for the hills quite yet. But it’s something we should keep an eye on.

12) The St. Louis Fed’s Smoothed Recession Probabilities indicator says we’re not in the “danger zone” at the moment. The indicator is “a dynamic-factor markov-switching model applied to four monthly coincident variables: non-farm payroll employment, the index of industrial production, real personal income excluding transfer payments, and real manufacturing and trade sales.”

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A Monday Dozen [CHART PACK]

Global macro is the willingness to opportunistically look at every idea that comes along, from micro situations to country-specific situations, across every asset category and every country in the world. It’s the combination of a broad top-down country analysis with a bottom-up microanalysis of companies. In many cases, after we make our country decisions, we then drill down and analyze the companies in the sectors that should do well in light of our macro view.

I never lock myself down to investing in one style or in one country because the greatest trade in the world could be happening somewhere else. My advice is to make sure that you do not become too much of an expert in one area. Even if you see an area that is inefficient today, it’s likely that it won’t be inefficient tomorrow. Expertise is overrated. ~ Jim Leitner

Good morning!

We’ve got record disconnects between flows and returns, unusual stock and bond performance, a wide disparity in sentiment between both, and much more… Let’s jump in.

1. Chart and note via BofAML with emphasis by me “Who’s buying: note record disconnect between flows & returns in 2019, only similar year was 2016; buybacks = #1 source of market support in 2H’19; US banks announced $129bn buybacks next 4 quarters.” See chart #5 from last week’s Dozen. Buybacks are set to accelerate beginning in August and run strong into the end of the year.

2. “STOCKS ARE OVERVALUED, STOCKS ARE OVERVALUED!!” The S&P 500 is trading at a P/FCF multiple that is well below its historical average (Chart via @1MainCapital).

3. There have only been 10 other times over the last 75-years when stocks and bonds have both put up double-digit returns over the same six month period (chart via NDR).

4. Stocks went on to outperform bonds each and every time over the following 12-months (chart via NDR).

5. BofAML’s Bull & Bear Indicator is close to triggering a “buy signal”. The indicator shows sentiment and positioning are near “extreme bear” territory.

6. Meanwhile, the S&P 500 closed at a new all-time high last week.

7. The Nasdaq McClellan Summation Index ($NASI) reversed from a temporary sell signal and is back in a strong uptrend.

8. Daily Sentiment (DSI) for the Nasdaq (NDX) relative to bonds is at extremely depressed levels (chart via @MacroCharts).

9. Consensus Inc’s Bond Sentiment Index shows bond bullishness at 7-year highs.

10. Morgan Stanley’s US Cycle Indicator is still in a downturn.

11. The US unemployment rate ticked up to 3.7% last week but is still well below its 12 and 36-month moving averages.

12. BofAML’s Asset Quilt of Total Returns. Notice how the returns for each asset class have almost entirely flipped from last year?

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A Monday Dozen [CHART PACK]

Well, I was worth over one million after the close of business that day. But my biggest winnings were not in dollars but in the intangibles: I had been right, I had looked ahead and followed a clear-cut plan. I had learned what a man must do in order to make big money; I was permanently out of the gambler class; I had at last learned to trade intelligently in a big way. It was a day of days for me ~ Jesse Livermore, Reminiscences of a Stock Operator

Good morning!

We’ve got over a century of equity volatility, falling Capex, contracting margins, and traders in a near PANIC. Here’s your Monday Dozen Chart Pack.

1. This is an awesome chart that I found floating around on the twitters. It’s from Bernstein Research and shows 119-years of equity volatility across five different macro eras. You can see that the percentage of time spent in recession (dotted green line) has trended lower and dropped considerably over the last century.

2. This chart from UBS shows how much single stock short interest has dropped over the last 3-years. Looks like people have kind of given up on shorting. Maybe it’s time to start increasing your short book?

3. Capex is a critical component of the Levy-Kalecki Profits Equation. Morgan Stanley’s composite Capex Plans Index fell again in June, back to levels last seen in mid-17’.

4. US Gasoline stocks, measured in 4-week average of days of supply, has fallen well below previous 5-year lows (chart via MS).

5. This chart shows UBS’s rolling 5-day Corporate Liquidity Signal (aka, buybacks). The net destruction of shares (more shares being taken off market through buyback and M&A relative to new issues) continues to be one of the most dominant drivers this bull cycle. It’s important to keep an eye on where net buybacks are trending.

6. This is one reason why we continue to be positioned net long the overall market.

7. This chart shows the current US Corporate before tax profit margins based against previous cyclical trough relative to past business cycles. We can see that margins are contracting but if this cycle is like past average ones, from a profit margin standpoint, then recession is still a ways off (chart via Societe Generale).

8. With average debt servicing costs for US companies at depressed levels, the force driving contracting margins is primarily labor costs.

9. The current spread in real effective policy rates between the Fed and the ECB is unprecedented (chart via Societe Generale).

10. Total speculative USD position. Lots of air to be let out of this trade. I’m short and looking to get more so (chart via GS).

11. This chart shows the number of 25bps hikes/cuts delivered every year relative to the amount of 25bps cuts already priced in over the next 12-months (chart via MS).

12. Citi’s Panic/Euphoria Model shows that overall sentiment is near “Panic” territory.

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A Monday Dozen [CHART PACK]

When traders think about money management, they think about stops and trade management. But a big part of the equation is knowing when to go all in, increase the leverage and press your trading to the hilt. Load the boat. These opportunities have an increase in volume and volatility. There is no point in actively trading in a dull market. Let the market tip its hand and come to life first. And then if you are fortunate to be in the groove and know you’ve got a tiger by the tail, milk it for all it is worth. This is where the real money is made. ~ Linda Raschke

Good morning!

We’ve got bonds that are massively overbought, spiking volatility in gold, a bearish consensus, and signs of increasing market strength. Here’s your Monday Dozen Chart Pack.

1. The UST 10-year yield moved below the 2% level last week (dotted red line) before quickly reversing. It’s at its lower daily, weekly, and monthly Bollinger Band and its weekly RSI shows it’s extremely oversold (green vertical bars). Do we see a reversal soon?

2. Gold volatility spiked over the last two weeks as the barbarous relic made a move above the all-important $1,400 level. Large jumps in volatility like this often mark short-term reversal points. Chart via SentimentTrader.

3. According to the BofA Fund Manager Survey, fund managers reduced their equity exposure last month by the second largest amount ever (largest occurred in August 11’). They now have their lowest allocation to stocks since March of 09’ which is 2.1std below their long-term average.

4. They LOVE defensives (cash, bonds, utes) and HATE energy, eurozone, and industrial stocks.

5. Citi’s Pulse Monitor Bear Market Checklist shows that the risk of a recession and an extended bear market remain exceedingly low. An “imminent bear market” signal is triggered when amber and red combined readings rise over 50% — current readings are 25% with only one “danger” warning.

6. Foreign demand for USD denominated securities has been weak but US corporate repatriation flows rose last year, following the tax cuts, which helped keep the US dollar elevated. These repatriation flows are now starting to turn over (chart via MS).

7. EURUSD 2-year swap rates and EURUSD have diverged, with swaps moving much higher. Swaps often lead the way…

8. FX volatility has not followed bond volatility yet… I think that’s about to change.

9. The strong dollar has dented US corporate profits over the last 18-months. A reversal in the DXY here would be a major tailwind to US MNCs.

10. Market breadth is STRONG. Another Zweig Breadth Thrust Buy Signal recently triggered. Total Put/Call 10dma indicator still has room to fall before a sell-signal is tripped.

11. The charts for silver miners look 🔥 + specs are getting pinched on crowded short positioning (chart below is a weekly of CDE).

12. The Three Pillars of US Macro (Labor, Liquidity, and Consumption) are still alive and well. An impending recession is unlikely.

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A Monday Dozen

In the final analysis, you need to have the courage to hold the position and take the risk. You need to be aware that the world is very sophisticated and always ask yourself: ‘How many people are left to act on this particular idea?’ You have to consider whether the market has already discounted your idea. ~ Michael Marcus

Good morning! We’ve got slowing global growth, the Fed’s room to maneuver, Canada Surprising, and some falling ROE… Here’s your Monday Dozen chart pack.

1. The percentage of PMIs around the world is still positive but shrinking fast.

2. The OECD Total CLI is at its lowest level since the GFC.

3. But it looks like it may be starting to base on a MoM and YoY basis.

4. The market is way ahead of the Fed but there’s still plenty of room for it to become more so.

5. Ed Yardeni’s Boom-Bust Barometer (dotted red line) suggests a pullback in equities may be coming.

6. The relative valuations of European banks are in the 1st percentile of their 10Y history — that’s the lowest since the height of the dot-com bubble. Is there any price at which EU banks become a buy?

7. Bonds and equities are telling two different stories. One of them is very wrong.

8. Here’s the MO Composite Sentiment Index. It includes a number of short and long-term sentiment and positioning data. Investors were pretty bearish going into last week but became more positive by Friday and are now slightly bearish/neutral heading into Monday.

9. What’s going on in Canada? America’s tophat has the highest Citi Economic Surprise Index (CESI) reading, by far. That means the economic data is coming in more positive than the consensus forecast.

10. Relative yields between the US and key trading partners have recently turned against the dollar (black line). Will the dollar follow suit or just shrug it off?

11. Relative growth though is keeping the dollar strong — at least for the moment.

12. Aggregate Return on Equity (ROE) may be rolling over again after it found a bottom in mid-17’.

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A Monday Dozen

The thing to do is watch the market, read the tape to determine the limits of the get- nowhere prices, and make up your mind that you will not take an interest until the price breaks through the limit in either direction. ~ Jesse Livermore

Every weekend I scroll through probably a 100+ charts. I figured I’d try sharing a dozen of the more interesting ones that catch my eye. Let me know if you find any value in this.

1. USDCAD has broken below a major support line (chart is a weekly).

2. Small-caps (IWM) bounced off their lower Bollinger Bands this past week (chart is a weekly).

3. As did crude (CL_F) (chart is a weekly).

4. Crude’s skew is at extremes suggesting a bottom is near (chart via @MacroCharts).

5. Total spec positioning in commodities futures at RECORD low levels (chart via @MacroCharts).

6. 10-year USTs (ZN_F) are trading above their monthly Bollinger Band. Reversal coming soon?

7. Consensus Inc. UST 10yr bullish sentiment nearing overbought levels.

8. AAII Net Bull/Bear Sentiment near Dec 18’ lows despite recent rally in stocks.

9. Investors continue to pile into credit after record outflows in December. This is a bullish sign for stocks as credit tends to lead equities.

10. NAAIM Exposure Index shows that investors are not buying this rally.

11. Morgan Stanley’s US Cycle indicator recently entered the “Downturn” phase.

12. Silver (SI_F) broke out of a descending wedge last week on strong volume. Commercial hedgers are net-long silver for only the second time in history.

 

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Macro Ops 2019 Mid-Year Performance Review

To others, being wrong is a source of shame; to me, recognizing my mistakes is a source of pride. Once we realize that imperfect understanding is the human condition, there is no shame in being wrong, only in failing to correct our mistakes. ~ George Soros

I learned that everyone makes mistakes and has weaknesses and that one of the most important things that differentiates people is their approach to handling them. I learned that there is an incredible beauty to mistakes, because embedded in each mistake is a puzzle, and a gem that I could get if I solved it, i.e. a principle that I could use to reduce my mistakes in the future. ~ Ray Dalio

Alex here.

Every six months we sit down and pore over our trade logs, journal, and public writings from the previous two quarters. We review what we thought markets would do, how we placed and managed bets on these opinions, and then compare them to how reality actually unfolded.

It’s a ruthless study of our mistakes; in thinking and in execution.

Like Dalio says, embedded in each mistake is a puzzle, and a gem”.

Pain + Reflection = Progress.

This is without a doubt the most valuable exercise we do.

Sharing this review process is unusual for a trading site. We’re one of the few services that are transparent with our performance. I know of many that tout their BS records by pulling gimmicks on a paper account, claiming nonsense 80% win rates, 350% annual returns, etc…   

We’re traders first and foremost. And as traders, all we have is our risk-adjusted P/L.

One of our principles when starting MO was to be completely forthright… to bare our warts and all (sometimes I feel like a leper). At the end of the day, like you, we just want to become better at the game of markets. Being fully transparent helps us do that.

The Palindrome (George Soros), one of the best to have played the game, had a win rate in the mid-30s. That means on average every 2 out of 3 trades he made were losers. Yet, the guy was a perpetual money machine over three decades. He knew how to lose and still win. Being good at being wrong is one of the most important skills a trader can develop.

One of my favorite market technicians, Ned Davis, put it like this.

We are in the business of making mistakes. The only difference between the winners and the losers is that the winners make small mistakes, while the losers make big mistakes.

Our job as speculators is to learn to make smaller and smaller mistakes by mercilessly studying our big ones. This is how we continuously refine our process in a way that increases the positive asymmetry of our trading approach over time.

This is akin to Josh Waitzkin’s concept of “making smaller and smaller circles”.

He notes.

It’s rarely a mysterious technique that drives us to the top, but rather a profound mastery of what may well be a basic skill set.

I’ve spent years dissecting the habits and practices of the greatest traders. And I can tell you that there’s no secret to anything they do.

They are just incredibly efficient at executing the basics:

  • Cutting losses short and protecting capital
  • Knowing when to sit on hands and letting winners run
  • Mental flexibility, strong opinions weakly held, respecting price as the final arbiter of truth

Now let’s look at our numbers for the past 6-months and see where we can make smaller circles.

Performance

Macro Ops Portfolio

  • Return Metrics *Through June 7th, 2019
  • YTD: 11.7%
  • Inception (Jan 1st, 2016): 43.7%
  • Annual Vol: 13.18%
  • Sharpe Ratio: 0.83
  • Max DD from NAV ATH: -17.5%

These are so-so returns and to be honest I’m not happy with them. Here’s where I screwed up.

Successful trading and investing can be boiled down to how well one does just two things:

  1. Analysis
  2. Trade management

Everybody focuses on analysis and trying to “pick winners” but it’s the latter, trade management, where the REAL money is made.

If you have good trade management you can get most of your analysis wrong and still make money. If you have good analysis but fudge your trade management then it’s a total crapshoot whether you come out on top and over the long-haul, you’ll almost certainly end up poorer than when you started.

A good example of this is an on-going experiment that one of our Collective members is running and which he’s been sharing in our internal group. He’s built a random trading system that picks entries in a wide number of assets completely by random (hence the name). The only part of the system that isn’t randomized is the position sizing and exits.

This system has been crushing it since inception.

For the last six months (well, 9 months really) our analysis has been on point but our trade management has been meh… We’ve called nearly every major turning point in a number of markets such as buying bonds at the start of November, going long stocks at the end of December, staying long stocks until the end of April, and then issuing a sell signal at the end of April calling for an extended decline before issuing a buy call last week.

But all of that is only good for 11+% year-to-date because of mediocre trade management. I only hope that our Collective members have profited from our analysis better than we have.

So what does this mean? What can we pull from this?

Well, first we have to make sure that we’re not falling into the trap of what poker players call resulting. This is where you assign meaning to statistical noise (aka randomness). It’s dangerous to make broad assumptions about skill and strategy based off of a few hands instead of many cycles at the table. So it is for traders and investors, where perfectly effective strategies can hit bad streaks that last weeks, months, and sometimes years.

Determining what time frame is appropriate for teasing out signal depends on one’s strategy, trade frequency, and a host of other variables. And even then, we never truly know what’s due to skill or luck — or bad luck.

That’s why we have to rely on logic and a certain amount of faith until we can compile enough data — experience enough cycles — to be able to pull valuable lessons from our results.

This brings us to an important point. And that’s that as a speculator, you will spend the vast majority of your time in a drawdown from NAV highs. This is a reality of all trading strategies that look to exploit convex opportunities.

The returns for these strategies are inherently bunchy. They follow natural power laws, like Pareto’s 80/20 distribution — or really it’s closer to 90/10 in markets.

This means we should expect 90% of our profits to come from 10% or fewer of our trades, with the rest canceling each other out. We can’t know beforehand when these bottom-line trades will come. We have to accept the fact that we’ll spend most of our time grinding away, taking strikes, hitting singles, and fouling out until we catch a fat pitch.

I’m confident that we’re not resulting and that our trade management was just crappy.

I’ve spent the last few weeks really thinking about this and searching for areas where I can improve my process. There are a number of obvious reasons why I’ve been less on the gun this year: I recently moved cross country, have been having to travel a lot internationally for work, am just finishing up going through a divorce, and experienced some health issues earlier in the year.

These things took up mind-space. They pulled me away from the screens for extended periods of time. They’re obvious performance detractors.

A good thing going forward is that my health is now better, I don’t plan on getting divorced again anytime soon :p, and I’ve purposefully reduced my traveling schedule so I can buckle down and manage our book more effectively.

After analyzing my trade management errors over the last 6-months I’ve concluded that my failures can be bucketed into the following:

  1. Being slow on the trigger leading to too much slippage and poor entries
  2. Being too loose with profit management in a volatile macro regime (ie, failing to take chips off the table once our stack has grown large)
  3. Just flat out not following up on our own calls (a symptom of being busy or away from screens).

We were up over 23% on the year in April but we ended up giving a handful of our profits back because I failed to fully carry out our call to significantly reduce risk + we’re holding a sizable amount of DOTM positions which naturally experience wild swings.

These are all easy fixes of better managing my schedule and getting personal things in order. I know for a fact that this area isn’t going to be a detractor of performance going into the rest of the year.

The more challenging problems are going to be improving our quantified rules and processes for managing trades, such as when and how to take profits. There’s a lot of room for improvement in this space and that has me really excited. I’ve been spending a good of time over the last few months working on this problem and I’ve had a number of a-ha! moments. We’ll be codifying these into our process in the coming weeks and writing up a long report laying out the changes and sharing this with Collective members. I’m excited…

Conclusion

Excellence is an art won by training and habituation. We do not act rightly because we have virtue or excellence, but we rather have those because we have acted rightly. Excellence, then, is not an act, but a habit. ~ Aristotle

We started MO just over three years ago with the aim of building a trading service/site that we always wanted but which didn’t exist.

We plan to continue busting our asses improving and evolving our value offered so that it stands head and shoulders above the other services out there; we want to be the best when it comes to research, education, trade theory, analysis tools, trading returns, and quality of our community.

We don’t aim to grow into a giant Motley Fool-type business because that would mean serving the common denominator. We want to foster a community of diehards — of traders and investors, who, like us, are single mindedly focused on becoming the best.

If you want to join us on our journey, then give the Macro Ops Collective a look.

The Collective is a solid community that continues to grow and compound its network — more ideas, better trades, bigger profits. If you’re serious about playing the game of markets well, then check it out below. To sign up, scroll to the bottom of that page.

There’s a 60-day money-back guarantee too. As I said, we’re always upfront with our community. That’s why we give you the opportunity to try the Collective for two full months before making a commitment. Come in, kick the tires around a bit and if at any time you feel it’s not a good fit, we’ll refund your money right away. No questions asked and no hard feelings.

We’re only keeping the doors to the Collective open till June 9th at midnight EST. After that, enrollment will shut down. Please take advantage before then.

Click Here To Learn More About The Macro Ops Collective!

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Genghis John and the Ultimate Mental Model for Markets

Revelation

A loser is someone — individual or group — who cannot build snowmobiles when facing uncertainty and unpredictable change;

Whereas,

A winner is someone —  individual or group — who can build snowmobiles and employ them in an appropriate fashion, when facing uncertainty and unpredictable change.

Snowmobiles?

I’ll explain in a minute.

First… Let’s talk about the man who wrote the above words — it’s part of a slide deck to a briefing that he spent much of his adult life working on.

That man is John Boyd. He’s one of the greatest fighter pilots who ever lived and a military strategist on par with the likes of Sun Tzu, Clausewitz, and Jomini. He perhaps has had more of an impact in shaping US military strategy than any American in history, and yet few know his name.

We’re going to discuss the immense philosophical contributions of Boyd and how we can use them to our advantage in markets — we’ll learn how to build snowmobiles and more. And as we’ll see, this is a timely discussion as markets have entered a period of large macro divergence and dissidence where coming trends will be affected by the Game Masters (political and monetary authorities) as much as the fundamentals.

We’ll use Boyd’s framework to analyze and synthesize current markets to discover what we think are the greatest opportunities, as well as the greatest risks…

And with that, let’s dive in.

We have to start with some background of the man to fully appreciate his insights, credibility, and accomplishments. It also helps that he was an extremely colorful figure whom tops the list of historical people you’d want to grab a beer with.

Back in the 1950s, Boyd was known as the best fighter pilot in America and perhaps the world. He flew for the US Airforce and reached the rank of Colonel. His first nickname (of many) was “40-second Boyd” because while working as a flight instructor at Fighter Weapons School, he had a long-standing $40 bet with all comers that he could put them on his “six” then outmaneuver them to reverse positions for a kill in under 40 seconds. Never once did he lose.  

Grant Hammond, the author of the original book on Boyd, The Mind of War, describes the complex man like this:

To one senior Air Force four-star, Boyd was “a 24 karat pain in the ass.” To a Marine four-star, he was “the quintessential soldier-scholar.” While one fellow student called him “the ‘cussingest’ man I ever met,” another four-start called him “Christ-like.” To those in the Pentagon whose ire he garnered, he was “that f @*#ing Boyd.”

He was known by various names including “the Mad-Major,” “The Ghetto colonel,” and “Genghis John.” To those who believed in him and his causes, he was more than a hero he was a virtual saint and they would have followed anywhere and taken on any foe, regardless of the odds.

How did one man inspire such radically different opinions? Boyd was both brilliant and a misfit who was his own worst enemy. He did not do things by the book or play by the rules. He did not care much for shined shoes, immaculate uniforms, or protocol niceties. On a visit to the Air Force Academy driving with his host, he noticed the superintendent in the car behind him on base. Boyd rolled down the window in the cold and snow and started pumping his middle finger in the air at the car behind, in front of several dozen cadets. His host, appalled by the action, tried to stop him, but Boyd said, “Aw hell, we were in pilot training together and this is just a fighter pilot greeting.”

Boyd was both vilified and respected by those who knew him. To many, he was not very likable. He smoked smelly cigars, talked loudly, and got right in your face when he argued with you, spittle flying. He was pushy, arrogant, and profane in the extreme and would frequently end run his boss, or his boss’s boss, up to, and including, the secretary of the Air Force and the secretary of defense. He had the courage to state his views—and defend them regardless of consequence. His supporters admired and respected his integrity and willingness to challenge and persevere. He was totally incorruptible, had little use for money, and refused to cash dozens of TDY reimbursement checks for speaking engagements after he retired. He inspired intellectual respect and virtual awe, intense loyalty, and unbounded compassion for those who became “the acolytes” of Boyd’s small but intense following on his various crusades.

Boyd was able to get away with being a “24-karat pain in the ass” and avoid court-martial only because he was brilliant.

In the late 1950s, he taught himself enough calculus to work out the formulas for describing his unique view of the maneuver-counter maneuver aerial dogfight. He published his findings in a secret document titled Aerial Attack Study. The document was so revolutionary it ended up spreading throughout Western military culture, essentially becoming the bible for air combat.

In the 60s, on his own initiative, he taught himself advanced mathematics and physics and then stole millions of dollars worth of government computer time using dummy accounts so he could study the comparative flight performance envelopes at different speeds, altitudes, and G-forces for every American fighter and plot them against every Soviet fighter.

Boyd did this because he wanted to answer the question as to why the F-105’s 10 to 1 kill ratio versus MiGs in Korea collapsed to 1-1 in Vietnam when US pilots seemed to lose their air-superiority.

Once the Air Force brass found out about his expensive theft they pushed for a court-martial. Luckily Boyd had uncovered fundamental truths about aircraft build and aerial warfare which led to his creation of Energy-Maneuverability theory, EM theory for short, which went on to completely change aeronautical design and how fighter jets were tested and built — eventually culminating in the creation of the F15 Eagle and F16 Fighting Falcon, two of the most successful fighter jets in history.

So instead of a court-martial, the Air Force was forced to give him two commendation awards instead.

Following his retirement from the Air Force in the mid-70s, Boyd went into self-imposed exile to study and prepare for the next phase in his evolution.

A former friend and coworker of Boyd, Frank Spinney, shared the following about this period in Genghis John’s life, during a speech given at the U.S. Naval Institute.

All this was the stuff of legend in 1973 when I met Boyd, who was living modestly with Mary the Saint and their five children in a run-down apartment complex in Northern Virginia. He was well into his third mutation: the Ghetto Colonel. Like Immanuel Kant, he was an austere man of intense rectitude, whose life had become devoted to the study of science, philosophy, and the humanities in a small room. Like Kant, Boyd was obsessed with understanding how the mind creates knowledge, or in modern parlance, how it creates theoretical models of the real world — how new observations make existing theories obsolete, and how the mind replaces old theories with new theories in a never-ending cycle of destruction and creation.

To this end, he devoured books on physics, mathematics, logic, information theory, evolutionary biology, genetics, cognitive psychology, cultural anthropology, sociology, political science, economics. Between 1973 and 1976, he poured his intellectual energy into producing a 16-page double-spaced, type-written paper describing his theory. Entitled “Destruction and Creation,” this abstract treatise describes how a dialectical interplay of analysis and synthesis destroys and creates our mental images of the external world. It describes what pressures drive this mental process, and how internal phenomena naturally regulate it in a never-ending dialectic cycle, which takes on the outward manifestations of disorder turning into order, and order turning into disorder.

At the heart of Boyd’s theory of knowledge was a natural regulation mechanism that he discovered by unifying for the first time certain aspects of the Incompleteness Theorem of Mathematics and Logic discovered by Kurt Godel, an Austrian mathematician; physicist Werner Heisenberg’s Uncertainty Principle; and the Second Law of Thermodynamics. Typically, he did not even try to publish his paper, although he did vet it through many distinguished scientists and mathematicians — none of whom was able to poke any holes in it.

“Destruction and Creation” became the intellectual foundation of his monumental study of competition and conflict — although at the time, he had no idea where his philosophical musings might take him.

Looking back at those four years between 1973 and 1976, I now understand that they were a period of intellectual refueling for the next campaign in Boyd’s war against a bureaucratic establishment that had lost sight of its goal. For unlike Immanuel Kant, Boyd worked in the Pentagon, a moral sewer dedicated to using other people’s money to feed the predators in the Hobbsean jungle known as the military-industrial-congressional complex.

Viewed from this perspective, the Ghetto Colonel’s lifestyle was much more than an aesthetic philosopher’s quirk. It was a deliberate choice reflecting that bureaucratic warfare in the Hobbsean jungle had replaced the aerial dogfight as his first love.

Boyd loved a good skunk fight and he played for keeps — instinctively applying Napoleon’s dictum of preparing a circumspect defense before unleashing an audacious attack. He built up his defenses by eschewing careerism and materialism, which left the generals and bureaucrats nothing to work on, no opportunity to gain leverage on him, no bait to tempt him into corruption. The Ghetto Colonel became an impenetrable fortress, a bastion of moral power in a way that Mohandas Gandhi would have easily understood. From the perspective of the bureaucracy’s authoritarian mentality, however, the man was certifiably insane; even worse, he was completely out of control.

I once asked him why he lived this way. He got in my face, the ever-present cigarillo clenched between his teeth, its hot tip popping up and down a quarter of an inch from my nose, and amidst a gush of suffocating smoke, he explained: “The most important thing in life is to be free to do things. There are only two ways to insure that freedom — you can be rich or you can you reduce your needs to zero. I will never be rich, so I have chosen to crank down my desires. The bureaucracy cannot take anything from me, because there is nothing to take.”

This statement went to the core of a puritanical ethos. For the Ghetto Colonel, life revolved around a simple choice: To be or to do? He could be somebody, with all the shallow accouterments of power and small achievements — high rank, a big office in the Pentagon’s E-ring, and a big post-retirement job with a defense contractor — or he could do important things and make a real contribution to society. The Ghetto Colonel was more interested in doing things than in being somebody, so he cranked down his needs. His choice really was very simple and logical, if somewhat bizarre and indecipherable to the inhabitants of Sodom on the Potomac.

There’s so many good bits in there that we could spill gallons of ink and burn through mountains of paper discussing them. But this is a report on markets, so I’ll save the broader philosophical discussions for another day and get to the meat of what we’re here for today.

Boyd’s decade long study into the nature of reality and how we interact and compete within it culminated in a 370 slide presentation titled A Discourse on Winning and Losing. The briefing covers a lot but at its core is an operating framework for how to survive and thrive in our complex reality.

The operating framework is what I’m sharing with you today. And underlying this framework is what Boyd referred to as his scientific trinity of Gӧdel, Heisenberg, and the Second Law of Thermodynamics.

Gӧdel proved that it’s impossible to embrace mathematics within a single system of logic so that any consistent system remains incomplete. In Boyd’s words, this means that “Gӧdel’s proof indirectly shows that in order to determine the consistency of any new system we must construct or uncover another system beyond it. Over and over this cycle must be repeated to determine the consistency of more and more elaborate systems.”

Meaning, there is always something beyond our contrived systems. No explanation is fully self-contained. Heisenberg’s Uncertainty Principle states that it’s impossible to know both the position and velocity of subatomic particles with accuracy. We can know either but not both at the same time. Boyd took this to mean that uncertainty lies at the foundation of our physical universe and therefore should be embraced by our attempts to understand and interact with it.

And the Second Law of Thermodynamics states that all closed systems increase in entropy over time (ie, chaos spreads). Boyd explained it like this, “entropy is a concept that represents the potential for doing work, the capacity for taking action or the degree of confusion and disorder associated with any physical or informational activity. High entropy implies a low potential for doing work, a low capacity for taking action or a high degree of confusion and disorder. Low entropy implies just the opposite.”

This is an oblique way of saying that in order to decrease entropy one must maintain an open system (open to new information, experiences, patterns etc…).

Hammond wrote in The Mind of War that Boyd’s thinking is:

…based on the synthesis of those three insights. It is cosmic in its sweep and fundamental in its insight. It is an elegant yet simple proof of how we learn and why one must be able to destroy before one can create. Boyd proved to himself that logic, mathematics, and physics all proffered explanations of the same basic notion. Taken together these three notions support the idea that any inward-oriented and continued effort to improve the match-up of a concept with observed reality will only increase the degree of mismatch. Boyd saw Godel, Heisenberg, and the Second Law as keys to how to think, how to compete successfully, and how to adapt and survive.

Boyd’s belief was that to compete in an uncertain reality — and all reality is tinged with varying degrees of randomness —  one had to constantly perform destructive deduction and creative induction with the mental models we use to interpret and interact with reality.

This means that we need to routinely dissect and analyze our beliefs, aims, and strategies (destructive deduction) where we can take note of, and discard faulty assumptions and biases. And then follow up with creative induction where we take our disparate analyzed data and models and then synthesize and combine it into something new, something novel, something that’s in better alignment with reality.

We need to build a snowmobile.

This was Boyd’s favorite metaphor for what we’re talking about. A snowmobile is a mismatch of various components from unrelated devices. It has the rubber treads of a tank, skis from a ski slope, the outboard motor of a boat, and the handlebars of a bicycle.

The individual parts of these unconnected objects (models) come together to create an entirely new creation, one that is better suited for its environment than any of the objects from which its parts are derived.

Scientist and author of one of my favorite books Consilience: The Unity of Knowledge, E.O Wilson put it like this:

We are drowning in information, while starving for wisdom. The world henceforth will be run by synthesizers, people able to put together the right information at the right time, think critically about it, and make important choices wisely.

Turning back to Boyd’s friend, Spinney:

Each of us bases our decisions and actions on observations of the outside world that are filtered through mental models that orient us to the opportunities and threats posed by these observations. As Konrad Lorenz and others have shown, these mental models, which the philosopher of science Thomas Kuhn called paradigms, shape and are shaped by the evolving relationship between the individual organism and its external environment.

In conflict, each participant, from the individual soldier, trying to survive to the commander trying to shape strategy, must make decisions based on his orientation to reality — his appreciation of the external circumstances which he must act on. Boyd argued that one’s orientation to the external world changes and evolves, because it is formed by a continuous interaction between his observations of unfolding external circumstances and his interior orientation processes that make sense of these circumstances. These interior processes take two forms activity: analysis (understanding the observations in the context of pre-existing patterns of knowledge) and synthesis (creating new patterns of knowledge when existing patterns do not permit the understanding needed to cope with novel circumstances).

The synthetic side of the dialectic is crucially important to one orientation because it is the process by which the individual (or group) evolves a new worldview, if and when one is needed to cope with novel circumstances. But as Kuhn and others have shown, the synthetic process can be extremely painful, because its nature is to build a new paradigm by destroying the existing one.

A big part of our job as speculators is to inch by inch try and pull back the curtain on a constantly changing complex reality. We do this by ripping apart our beliefs and rebuilding new ones, creating Munger’s latticework of mental models, from which we can pull from when the environment calls for it.

Some of the models we’ve shared for example are: 

What Boyd gives us, which is so incredibly valuable, is a strategic framework from which to effectively use these models and operate from.

The framework is called the O-O-D-A Loop which is an abbreviation for Observe, Orient, Decide, Act.

The OODA Loop is the ultimate compression of Boyd’s philosophy. Hammond writes that for Boyd, “the OODA Loop is a composite of how we think and learn, the source of who we are, and the potential we possess. It is a profoundly simple explanation of the nearly infinite variety that is possible. It is a shorthand for life itself, a model for how we think, and the means by which we both compete and collaborate.”

Boyd describes the centrality of the OODA Loop as this:

Without our genetic heritage, cultural traditions, and previous experiences, we do not possess an implicit repertoire of psycho-physical skills shaped by environments and changes that we have previously experienced.

Without analysis and synthesis across a variety of domains or across a variety of competing independent channels of information, we cannot evolve a new repertoire to deal with unfamiliar phenomena or unforeseen change. Without a many-sided implicit cross-referencing process of projection, empathy, correlation, and rejection (across many different domains or channels of information), we cannot even do analysis and synthesis.

Without OODA Loops, we can neither sense, hence observe, thereby collect a variety of information for the above process, nor decide as well as implement actions in accord with these processes. Or, put another way, without OODA Loops embracing all the above and without the Ability to get inside other OODA Loops (or other environments), we will find it impossible to comprehend, shape, adapt to, and in turn be shaped by an unfolding, evolving reality that is uncertain, ever-changing, and unpredictable.

The entirety of the OODA Loop process looks like this:

Notice the continuous feedback loops at each step of the process. Ever stage of the OODA Loop informs the other and so on. The process is more organic than it is mechanical. Never is it static but rather it’s constantly fluid; always updating, reorienting, evolving.

Now how does all of this apply to markets?

For one, prediction is not only futile but completely misses the point of the game. Prediction only works in linear environments whereas markets are a natural system, and thus are dynamic, non-linear.

Just like in war you don’t set a strategy, execute, and pray to Mars that you chose wisely. No!

You Observe what’s going on, and then Orient off what you see as key information, then make your Decision using existing mental models for interpreting reality and finally Act… You then repeat and repeat over and over… constantly observing and reorienting to not only new information but new interpretations of that information — ruthlessly trashing your bad assumptions —  and then hopefully evolving your models of reality, deciding what to do next, and following through ad infinitum…

If you study the trading greats you find that they did the OODA Loop process instinctively.

Take the Palindrome, George Soros, for example, who’s said:

My approach works not by making valid predictions, but by allowing me to correct false ones.

The reflexive nature of human relations is so obvious that the question I would like to ask is, why has reflexivity not been properly recognized? Why, for instance, did economic theory deliberately ignore it? [And the answer is because] it cannot be reconciled with the goals of analytical science, which is to provide determinate predictions and explanations. Reflexivity throws a monkey-wrench into the works by introducing an element of uncertainty.

As an investor, I find statistical probability of limited value; what matters is what happens in a particular case. The same applies with even greater force to historic events. I cannot make reliable predictions about them; all I can do is formulate scenarios. I can then compare the actual course of events with the hypothetical ones. Such hypotheses have no scientific validity, but they have considerable practical utility. They provide a basis for real-life decisions.

Or Bruce Kovner:

One of the jobs of a good trader is to imagine alternative scenarios. I try to form many different mental pictures of what the world should be like and wait for one of them to be confirmed. You keep trying them on one at a time. Inevitably, most of these pictures will turn out to be wrong — that is, only a few elements of the picture may prove correct. But then, all of a sudden, you will find that in one picture, nine out of ten elements click. That scenario then becomes your image of the world reality.

These guys can build snowmobiles!

What is strategy? A mental tapestry of changing intentions for harmonizing and focusing our efforts as a basis for realizing some aim or purpose in an unfolding and often unforeseen world of many bewildering events and many contending interests…

To discern what is going on we must interact in a variety of ways with our environment. We must be able to examine the world from a number of different perspectives so that we can generate mental images or impressions that correspond to that world.

We can’t just look at our own personal experiences or use the same mental recipes over and over again; we’ve got to look at other disciplines and activities and relate or connect them to what we know from our experiences and the strategic world we live in. By an instinctive see-saw of analysis and synthesis across a variety of domains, or across competing/independent channels of information, in order to spontaneously generate new mental images or impressions that match up with an unfolding world of uncertainty and change. ~John Boyd

Leonardo da Vinci once said, “He who loves practice without theory is like the sailor who boards a ship without a rudder and compass and never knows where he may cast.”

Markets are tremendously complex systems. As traders/investors we play a game of uncertainty, filled with endless possibilities, that we must try our best to effectively weight probabilistically. Mental models give us a scaffolding to hang our experience on and help us navigate violent waters. Boyd’s OODA Loop is one of these models that once you begin using, to then discard would feel like drifting about without “rudder and compass”.

If you liked this article then you will love The Macro Ops Collective. We use mental models like the OODA loop to continuously triangulate the most probably path forward for every macro market. The Collective houses our best research as well as a real-time record of all of our macro trades.

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Playing The Player Update: Another Major Buy Signal

The best trades are the ones in which you have all three things going for you: fundamentals, technicals, and market tone. First, the fundamentals should suggest that there is an imbalance of supply and demand, which could result in a major move. Second, the chart must show that the market is moving in the direction that the fundamentals suggest. Third, when news comes out, the market should act in a way that reflects the right psychological tone. ~ Michael Marcus

Michael Marcus is one of the original market OGs. He cut his teeth at Commodities Corp where he was one their star traders alongside PTJ, Kovner, and Ed Seykota.

Marcus combined fundamentals, technicals, and sentiment — what we refer to as the ‘Marcus Trifecta’ — to analyze markets. This allowed him to turn $30,000 into $80 million over a 20 year period. Not too shabby.

This is the approach we use here at MO to view markets. In this piece, I’m going to share an excerpt from two Market Briefs that went out to members of our Collective recently. The hope here is to first show you some of the tools and processes we use to assess markets. And secondly, to give you an update on what we’re currently seeing through this ‘Trifecta’ lens (this is complimentary info to the note we sent out yesterday).

The following excerpt is from our Brief titled “A Roadmap” published May 29th.

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Let’s quickly layout where we are and how we got here. And then we’ll get to where we’re headed in the weeks ahead.

In our April 23rd Brief “Japan Going On Leave” we began noting how the rally had gotten “long in the tooth” and there were increasing “signs of growing complacency and technical divergence”. We talked about how the Russell small-cap index had “failed to confirm the broader market rally” and that not only had credit and spreads “turned over a bit” but sentiment and positioning were becoming stretched, writing:

The majority of investors have been on the outside looking in at this rally since the start of the year. We’ve talked about how this move will persist until it finally creates enough FOMO (fear of missing out) to suck in these players who’ve been sitting on the sideline.

While we likely have a bit more to go before we get total capitulation from the bears. There’s an increasing number of signs that we’re getting close. Take the NAAIM Extreme Exposure Index which measures the top quartile of investor’s weighting to risky assets. It recently pierced the 80 level (horizontal red line). Readings above this point suggest a number of investors are getting over their skis a bit which makes the market more susceptible to a pullback.

Then in our following Brief “Creeping Complacency” we pointed out that “ Our 10-day moving average Total Put/Call indicator crossed below the 0.8 level (marked by the horizontal red line below) triggering an official sell signal on Friday.  Investors are buying less downside protection and are becoming complacent. The lower this indicator moves the greater odds are that we’ll see a sizable correction in the coming weeks.”

We concluded with “My general market take remains the same. The rally is getting long in the tooth and there are some increasing signs of FOMO — note the resurgence of the “Melt-Up” narrative that last became popular in the runup to the Jan 18’ blow off. But momentum and technicals still favor more upside for the time being.

The move here is to stay long but begin to trim risk and take some profits off the table. Once momentum fades and more technical cracks appear we’ll move to more aggressively reduce our equity exposure and put on some shorts.

The following week we wrote in the MIR that “The Forward PE ratio of the SPX is back up in the 17+ range. A level which has caused some instability for the market in the past.”

And ended with:

My indicators are telling me that we’re headed for a broader market correction in the coming weeks. I’m not expecting this to be a big selloff like the one we experienced in Q4 of last year but it could be significant in some of the individual overstretched names.

…We’ve been writing since last December that the majority of the market has been on the outside looking in at this rally and that the time to get defensive will be when those on the sidelines begin giving into FOMO and piling stocks. It looks like that is starting now. Momentum may carry us higher for a bit longer but we’ll be taking this time to begin reducing our exposure to some of our more richly valued growth names and allocating more to our value names above.

Sentiment, technicals, and macro… The “Marcus Trifecta” is a very useful approach for hitting broader market turning points. The signs for this current selloff were there for all to see who knew where to look.

***Here’s the conclusion to our most recent Market Brief “The Market is Teeing Up…” from which yesterday’s macro indicator discussion was pulled.***

…. We have macro fundamentals which are slowing but still positive and far from signaling a recession is nigh. Depressed yields fatten the risk premia on offer from risk assets, making stocks appear more attractive. The consensus earnings estimates have been driven down to very manageable levels which should make for easier ‘beats’. Sentiment, positioning, and technicals are all pointing to a significant market bottom in the coming weeks. On top of all this, we have a US dollar that looks like its breaking down. A lower dollar = a tailwind for US earnings and easier financial conditions for EM stocks, not to mention a big positive for commodities.

Back at the end of March, I wrote There’s a Big Macro Move Brewing in Markets noting the record low asset volatility we were seeing in major dollar pairs and precious metals. I laid out how these compression regimes usually lead to expansionary ones (ie, BIG TRENDS). I think we’re going to see that start very soon.

There are a number of trades setting up that are making me excited. There are energy and shipping names trading at 1x normalized free cash flows and I’m seeing signs that investors are FINALLY starting to allocate money to the sector — I’ll write more about both soon. There are fantastic shorting opportunities lining up in the overvalued tech names. And we have bonds that are in the process of putting in what looks like an intermediate blow-off top.

I’ll be putting out a series of notes and trade alerts for Collective members in the coming weeks to update you on things as they unfold and as we make moves in our portfolio.

 There is a tide in the affairs of men,
Which, taken at the flood, leads on to fortune;
Omitted, all the voyage of their life
Is bound in shallows and in miseries.
On such a full sea are we now afloat,
And we must take the current when it serves
Or lose our ventures.
~Shakespeare

Time to take the current…

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Honma Munhisa, the 18th-century Japanese rice trader who invented Candlestick charts, is believed to have amassed a fortune of over $100B in today’s money trading rice futures. He learned early on that making money in markets is as much about “Playing the Player” as it is about understanding the fundamentals. He wrote:

When people run to the West, I turn to the East. When the rice price starts going up, orders rush in from everywhere all at once, and soon the Osaka market becomes part of the show as well. The rice price goes up faster when people place orders even for stored rice and it becomes more evident that a buying spree is taking place. But when you wish to be in the position to place buy orders like everybody else, it is important to be on the side of those who place sell orders. When people move in unison, running towards the west with determined intention to be part of the rally, it is time for you to head to the east and you will discover great opportunities.

Looking at the market it seems like there are a lot of people crowding to one side or “running to the west”.

The last time I saw sentiment hit similar levels relative to the fundamentals was in late December of last year. On December 18th, I wrote the first of many bullish notes titled “The Bullish Case for US Stocks” commenting on the extremes in sentiment and narrative, ending with “I believe US stocks are setting up for an extraordinary buying opportunity in the next 1-3 weeks. I see a LOT of amazing deals in stocks and I’ll be putting out our Macro Ops shopping list later this week.”

The Trifecta of data tells me we’re about to see a similar bottom very soon.

It might be time we start running to the East

Before you go, we’re currently doing an open enrollment for our premium macro research offering called The Macro Ops Collective. If you want access to our latest and greatest stuff click the link below and make sure to sign up by June 9th at 11:59PM EST!

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The Market is Teeing Up…

The following is an excerpt taken from our latest weekly note that was sent to Macro Ops Collective members.

We’re going to cover a lot in this week’s report. We’ve got trade wars, trade wars, and some more trade wars… Regulatory action against tech giants… A look at sentiment and technicals which are setting up for a significant bottom… And finally, we’ll walk through the major macro indicators to dispel the nonsense being peddled about an impending recession… Oh, and then we’re going to cover some trades that are teeing up… Pour yourself a fresh cup of joe, strap in, and let’s get cracking.

I don’t know about you but I want me some of whatever President Trump is smoking. The Donald has been non-stop these last few days.

Growing bored with an escalating trade-war with China he — apparently on a whim — decided to start one up with our Mexican Neighbors in an effort to get them to do something about their porous borders. Despite the fact that we just signed a major trade deal (USMCA or New Nafta) with them last December which took over a year of negotiations to hammer out.

Not wanting to stop there he then decided to remove India’s “special trade status” which exempted the country from US tariffs and followed that up with an effort to hit that thieving Australia with tariffs of their own before being talked back amid fierce opposition from military officials, as well as the State Department.

It looks like Trump has become besotted with the total discretionary authority that tariffs give him. No checks and balances, no going through Congress; he can wield near instantaneous economic force from his smartphone. Macro Hedgie Mark Dow summed up the implications of this well, tweeting:

Goldman Sachs shared their revised expectations of the trade war’s impact this weekend, writing:

We now expect a 10% tariff rate by July on both the final $300bn of Chinese imports (60% subjective odds) and on all Mexican products (70% odds for the first 5%, and just over 50% odds for the step-up to 10%).”  For China, this represents a middle ground between our previous assumption of a delay following the G20 summit in late June and the full 25% across-the-board tariff proposed by the US Trade Representative.

Additional tariff rate increases or an across-the-board auto tariff are also possible but not our base case. We still expect deals with China and Mexico to lead to a removal of the tariffs, but not until late 2019/2020.

We don’t have an edge in figuring out what the Trump admin or those on the other side of his trade fury will do. GS’s expectations are as good as any. They calculate that this base case will impact inflation, where they see it “climbing from 1.57% in April to 2% in August and to 2.3%-2.4% in early 2020” and dinging GDP growth in the second half by roughly 50bps.

Precise numbers aren’t that important here, in my opinion. What matters more is how this continues to widen the Cone of Uncertainty, not only for investors but for participants in the real economy. This is where the real risks lie, which are two-fold. These are (1) that this trade war escalates and creates a bear market of unnecessary stupidity which, due to the financialization of the economy, then leads to a recession and/or (2) private fixed investing (capex) collapses due to an inability for businesses to plan which then leads to a profits recession in accordance with the Levy-Kalecki framework.

As an example. Here’s some comments included in the recent Dallas Fed Manufacturing Survey (emphasis mine).

Primary Metal Manufacturing

  • The possible increases in tariffs related to China will negatively impact our agriculture customers and put further pressure on a segment that is already experiencing cyclical lows.

Nonmetallic Mineral Product Manufacturing

  • There are many unknowns due to tariffs.

Machinery Manufacturing

  • There has been a sharp decline in orders, and pricing has taken a huge dive as well. Competition has pushed pricing to near-guaranteed losses.
  • With all the tariff fees pouring into the U.S. Treasury, when should we expect a tax break?
  • We are seeing steady business that should begin to grow again if a China trade deal is reached.
  • China tariffs were already causing significant price increases, and the latest escalations will raise our costs even more—probably our prices, too—and make us less competitive on the world stage where we export 70 percent of what we produce.

Computer and Electronic Product Manufacturing

  • Trade talks with China could have a longer-term impact but have no impact at this point.
  • Growth is robust and would be even stronger without current supply chain and labor constraints, but we aren’t complaining.
  • With our government’s intention to resolve issues with Iran and China and also introducing the “Deal of the Century,” it adds warranted risk to our future business that we can’t ignore.
  • There is significant uncertainty.

Transportation Equipment Manufacturing

  • We are changing our business model to increase volume, with pricing based on wholesale margins versus retail margins. This change is to be phased in over six months.
  • Our primary customer is the U.S. government. We continue to be concerned regarding the volatility of the decision-making processes at the higher levels.

Net investment is what drives profits over the long-term. Growing regulatory and trade uncertainty makes operators less willing to make long-term investments. Private fixed investment is still growing at a healthy clip of 5% in the most recent quarter. But it’s also rolled over from its most recent high reached in Q2 of last year. If the trade war escalates and we see this number continue to fall then we’ll maybe want to start battening down the hatches.

The Regulators are Encircling the Tech Giants

Here’s a few sections from a recent article by Reuters (link here).

(Reuters Breakingviews) – At some point, antitrust investigations of Google and Amazon.com AMZN.O become a no-brainer. As a step in that direction, the Federal Trade Commission and Justice Department, which police U.S. competition issues, have divvied up responsibility for the tech giants, according to news reports. That could create ammo for future fights. Facebook FB.O ought to worry too.

… Splitting jurisdiction between the FTC and DOJ – which have overlapping remits – is a logical way to clear the decks. It avoids overloading one agency, duplication of work, and bureaucratic infighting. It will also leave each to explore different approaches to big questions like how troves of data on users and suppliers affects competition – something on which regulators worldwide are feeling their way.

Politics also raises the stakes, notably at the DOJ, which was already scrutinizing social media firms for alleged bias against conservatives after pressure from President Donald Trump. Antitrust scrutiny of Google has been informed partly by competitors’ complaints, including those by Oracle ORCL.N, whose Co-Chief Executive Safra Catz served on Trump’s transition team.

In the past, U.S. regulators have failed to make a dent on Google and software giant Microsoft MSFT.O, and they may achieve little again. These investigations could, however, establish important precedents that, a few years from now, inform more dramatic skirmishes.

The popular high-growth tech names are getting hammered on this news. This thread does a good job of laying out the implications of this. Basically, high-growth tech/SAAS plays have been the ONLY game in town these last few years. They’ve become hedge fund hotels where positioning concentration has reached ridiculous levels + when you couple that with the rather low volatility and high momentum we’ve seen in many of these names, you get a ‘fire in a crowded theatre’ type scenario where a bunch of weak hands end up clambering for the exit at the same time.

I wrote about the shift that’s underway from growth to value in last month’s MIR (link here). [For access to this content sign up to the Macro Ops Collective by Monday June 9th!]

Here’s one of the charts from that report showing the cyclical swing between growth/value on a momentum basis.

We’ll be looking to put out shorts in a few of these Icarus stocks in the coming weeks.

Slowing Growth but NOT a recession…

It’s been a few weeks since we’ve taken a macro fundamental look at the US market. And since I’ve seen a lot of screaming and hollering about an impending recession I thought I’d dust off a few of our mainstay recession indicators to see if that’s a high-probability risk. The short answer is, of course, no.

Let’s start with the Conference Board Leading Economic Indicator (LEI). The LEI is a composite of 10 leading economic and market indicators. You can read more about it here.

The LEI has given an advance signal of all eight recessions since its inception in 1959. It peaks on average of 10.5 months before a recession comes. The graph to the right shows the average returns per state of the LEI.

The chart below, which exhibits the LEI on an absolute and YoY basis, shows that the indicator is still heading up and to the right, though at a more muted pace.

Let’s turn now to labor. There’s a lot of ways to slice the jobs market but we’ll look at two of the stalwarts that I prefer — the other labor indicators I keep an eye on tell the same story.

The first is the Conference Board Employment Trends Index which, like the LEI, is an aggregate of eight labor market indicators (you can read more on it here).

The chart below shows that it peaked on an absolute basis back in August of last year and has flat-lined since but is still positive on a 12-month basis. We shouldn’t be worried though until this indicator turns negative.

Then we have Temporary Help Service Payrolls on a monthly, quarterly, and yearly basis. After a brief soft-patch at the start of the year, the data is back in the black showing positive growth. This indicator will turn over and begin to bleed a lot of red before a recession rolls around (see 00’ and 07’).

Inflation-adjusted Retail Sales are another reliable leading indicator for the economy and though growth has slowed it’s still positive. If it rolls over and continues lower from here then we’ll have to start getting concerned.

Lastly, let’s take a look at financial conditions (aka. liquidity). Like the labor market, there’s a lot of ways to gauge liquidity. We’ll look at a few of my favorites like this one, the Kansas Fed Financial Stress Index (KFSI) which is comprised of 11 financial market variables (read more here).

The KFSI is very muted, showing easy financial conditions. This indicator will turn and spike higher in the lead up to a recession, as it did in the summer of 07’ and 99’.

The Chicago Fed Adjusted National Financial Conditions Index (ANFCI) summarizes 105 indicators of financial activity (read more here). Like the KFSI, this indicator is trending sideways and near very low levels, showing easy financial conditions despite the recent bout of market volatility.

So we have uptrending LEIs, a strengthening labor market, positive real retail sales, and easy financial conditions. The bears will say “what about the inverted yield curve!?”.

A yield curve inversion does have a reliable track record of predicting recessions but my answer to that is threefold (1) an inverted curve should not be dismissed, but we need to look at the evidence in its totality and not just select one data point that confirms our bias (2) the signaling utility of parts of the curve may be somewhat less reliable this cycle, as I’ve noted here and (3) parts of the curve are still positive, such as my go-to, the 10-2s.

With all that said, our base case is that growth will continue to slow (we predict real GDP growth for the year to come in around 1.5%).

Slowing growth is not a recession and a low growth / low inflation economy is not a bad environment for risk assets as Stanley Druckenmiller has pointed out numerous times.

The major thing we look at is liquidity, meaning as a combination of an economic overview. Contrary to what a lot of the financial press has stated, looking at the great bull markets of this century, the best environment for stocks is a very dull, slow economy that the Federal Reserve is trying to get going… Once an economy reaches a certain level of acceleration… the Fed is no longer with you… The Fed, instead of trying to get the economy moving, reverts to acting like the central bankers they are and starts worrying about inflation and things getting too hot. So it tries to cool things off… shrinking liquidity… [While at the same time] The corporations start having to build inventory, which again takes money out of the financial assets… finally, if things get really heated, companies start engaging in capital spending… All three of these things, tend to shrink the overall money available for investing in stocks and stock prices go down…

Oh… I also want to point out the trend in US Profit Margins and Return on Equity (ROE). Both are important to watch as they directly drive equity valuations.

Starting with ROE, we can see that following an extended contraction that began in 12’ it’s actually begun to trend back up after bottoming in 17’. ROE will typically compress in the lead up to a recession.

Net US Profit Margins also peaked in 12’ but are still holding up pretty well. Like ROE, we will see margins compress in the lead up to a recession.

In our next piece, we’re going to cover the Market Trifecta: Fundamentals, Technicals, and Sentiment.

We’ll discuss how consensus earnings growth expectations have been walked down to much more manageable levels, then I’ll show you how key markets are nearing major support levels, and finally finish with a look at sentiment and positioning which is indicating that we’re nearing a significant bottom (ie, a big buying opportunity is setting up).

I’m seeing a LOT of wildly asymmetric trading opportunities that are teeing up. We have energy and shipping names trading for 1x normalized FCF, major FX pairs that are about to break out of significant compression zones, and bonds which are keyed for a big reversal. I’ll write more about these in a coming note for Collective members.

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