Mark Rzepczynski, Author at IASG

There are many narratives for why equities or bonds will move higher, but a recurring theme is the financial conditions faced by investors. Financial conditions provide the tailwinds or headwinds to push asset class returns. These conditions tell us something about whether we will be transitioning between a risk-on and risk-off environment or whether we will be a crisis mode.

How do you know whether a model is broken? Or, how do you conduct a model review? There are many specific steps for any review but there are four major questions that have to be addressed that are separate from risk management. The key question of model efficacy should focus on forecasting skill and action. Does the model forecast correctly and is the model employed properly to make good decisions.

Globalization is a critical part of macro investing. There can be talk of separation politics, but for investors, you have to focus on the global economic cycle because the world is highly integrated. What is very interesting is that globalization has been fairly stable between the current environment and the Bretton Woods period as discussed by the recent work of Eric Monnet and Damien Puy who studied long horizon data available from the IMF. They find that there were two common shock periods which caused a highly synchronous global behavior. The first was oil shock period of the 70’s and the second was the Great Financial Crisis. You could say that these were the two periods when “correlations went to one” across asset classes. There was no international diversification benefit.

A growing stream of thinking in microeconomics is the concept of “winner-take-all” dynamics. The idea seems simple. A combination of networking economics and classic economies of scale creates situations where there are just a few dominant firms or economic agents who are able to capture significant market share in a given industry. With the advances in technology over the last decade, many industries are seeing the impact of winner-take-all dynamics leading to the result of greater concentration.

March was a tough month for making any economic judgments. The Trump rally in equities was expected to continue, but reality has been a switch to non-US risky assets. A bond sell-off was expected given Fed action combined with more fiscal policy revelations. It did not happen. The dollar was expected to continue its rally based on further confirmation of the Fed being out of step with other central banks. It did not happen.

March saw a significant rotation in return performance from US equities to global and emerging markets and from value to growth. Our indicators show prices are starting to break to the downside albeit trends are currently flat. March was a transition month from euphoria to reality concerning US government policies. Future price direction will be determined by the real economy and not policy expectations.

Managed futures declined on market reveals from the Fed FOMC announcement of a 25 bps rate hike. While the move seemed to have been baked into market thinking before the announcement, key asset classes revised trend direction after the 15th. The SPX, which was already flattening in trend, turned lower. Bond returns, (long duration), actually turned higher on a perceived more aggressive Fed. The dollar strength reversed and commodities moved higher after declining for the last month. You get the picture on the change. Trend-followers saw a reversal in performance which added to a lower overall return.