Deep Quad 4 to Deep Quad 3

Conference call with Keith McCullough

Keith talked us through Hedgeye’s 3rd Quarter Macro Themes presentation in which he discussed their Quad based rate-of-change approach to asset allocation and risk management. There is a huge mismatch between what the markets are saying and what Hedgeye’s models are showing. The US economic cycle peaked three quarters after the global cycle peaked in 3Q18 which is when they made their first Quad 4 (slowing growth and decelerating inflation) call in 4Q18. The virus emerged as an exigent shock, but fragility left the cycle susceptible to any catalyst. We headed into deepest Quad 4 in 2Q20. Now Keith believes that the US economy is transitioning to recession stagflation, essentially from depression to recession, but certainly not recovery. He showed that the profit cycle is about to slow to the deepest point and believes an epically negative earnings revision cycle will commence in Q3. We came in to this super pro-cyclically levered in 4Q19, profits were already negative YoY, so it was already late cycle which is why we saw corporate bond bubbles and many other bubbles. We are trying to solve a leverage problem with yet more and more leverage. 60% of companies have already spent half of the government bailouts. 75% of small businesses said they could not survive 4 months with no revenue and now we are at the 4-month mark and COVID is back! Surely, thousands of bankruptcies are around the corner? It is going to take a very long time to sort everything out. The list of data points that Wall Street pumps up to offer hope are misleading. To be confident in a recovery, focus should be on YoY figures - which are deeply concerning, not sequential numbers.
In terms of recommendations, Keith believes stocks will enter bear territory or even crash mode. He recommends shorting the Russell 2000 - not the S&P 500 as they like REITs and Utilities which are bond proxies. Long Energy, Gold Miners and Short Financials, Private Equity, High Yield and Healthcare. Biggest allocation to Treasuries, TIPS and Gold. Long IG Credit since bond issuance over the first six months of this year is bigger than any full year over the last decade. They think that inflation will accelerate, therefore they are short the dollar and long commodities for the first time in a very long time, particularly Ags - Corn and Livestock. Bullish Emerging Markets but very selectively including China, Russia and Indonesia. Short Spain and Italy equity markets.