Recent interviews with Steve Einhorn, the long-time hedge fund manager, provides his checklist for when a bull market may turn into a bear market. It is not supposed to be a definitive forecast, but a good simple indication when conditions are ripe for a change. See Boyer Blog and Barron’s .
Reading the Bank of International Settlements (BIS) annual reports and the speeches of Jaime Caruana, the BIS General Manager, who finished his term at the end of last year, I formed a simple checklist of the recurring themes he has focused on in his work. For the last few years, he has emphasized four factors which he closely watches to determine whether there will be a financial downturn:
There has been a bubbling up of new ideas on fees for money managers. These discussions are focusing on the conceptual framework for fees in order to change the thinking of both managers and investors. A battle to just lower fees between large investors and managers is a lose-lose situation. Managers who do their job well are frustrated with these discussions and investors feel they are disadvantaged when managers underpeform. See the latest piece from my friend Angelo Calvello, Your Fees Are Bull%$&. The capital rental concept should be explored further.
You might think some research is obvious after the fact, but in reality, good research can allow us to deepen our understanding on a topic and may provide subtle insights that were unexpected. One topic of interest is competition and rivalry.
The returns of alternative risk premium strategies and products developed by banks and investment managers will have close links with the underlying macro relationships that are modeled. In the case of credit carry risk premiums, investors will gain from the difference between high yield and investment grade spreads. In the case of rate carry risk premiums, returns will be tied to the term premium in the yield curve.
Volatility has fallen since the February vol-shock, but the vol-of-vol shock paints a deeper picture of the calm that has overtaken the equity markets. This same behavior is seen in other asset classes. Given the combination of geopolitical risks, economic uncertainty, and policy changes, should we expect this level of calm? It seems unlikely.
Investors want diversification from their equity exposure. This desire for diversification increases with uncertainty and with expectations of an equity decline. The big question is how or where are you going to get this diversification. The diversification winner for the post Financial Crisis period has been simple, US bonds. Bonds have been an asset that generated a good rate of return with lower volatility and a negative correlation with equities. You could not ask for a better diversifier. Unfortunately, the investment environment is changing and the benefits from bonds may no longer be available, so there is an increased desire to find new diversifiers.
Ben Bernanke, former chair of the Federal Reserve. “In 2020, Wile E. Coyote is going to go off the cliff and look down.”
Alan Greenspan, also former head of the Fed. “There are two bubbles: a stock market bubble and a bond market bubble.”
Scott Minerd, Guggenheim Partners chief investment officer. The market “is on a collision course with disaster” and the catastrophe will hit in late 2019, with stocks losing 40%.
Jim Rogers, founder of the Quantum Fund. “When we have a bear market, and we are going to have a bear market, it will be the worst in our lifetime.”
From Forbes 4 Financial Savants Warn About The Great Crash Of 2020 Larry Light
These four experts are telling us doom is ahead. Call it Wile E. Coyote moments, double bubbles, bear of bears or a collision course with disaster, the prediction is the same – wealth destruction is coming. These are the usual doomsday stories. They may be right but there seems to be a natural bias to the dark side. We seem to like it and pundits keep feeding us these narratives.
Commodities, as an asset class, have had exciting performance year; well maybe, if you had the right index. A quick look at returns over the last year shows that if you held the SPGSCI index through the GSG ETF, you would have gained a very attractive 19 percent return. If you held the broader-based Bloomberg commodity index (BCOMM) (DJP ETF) you would have received only 3.2%. Both are well-defined indices, but the performance difference would have been in the double digits. This is all based on the weighting of the index. SPGSCI has a 2/3rds weighting in energy while the BCOMM only has a 30 percent energy weighting. If you liked energy, you would have been a star. If you preferred diversity, you would have been made only a slightly positive gain.
What did we learn from the February volatility shock? Volatility has trended lower and the same trades are being put into play; short volatility. Looks like the market has a short memory.
The survey from the International Association of Credit Portfolio Managers shows a significant change in the sentiment of credit managers on the direction of credit spreads. The diffusion index which ranges between 100 and -100 shows that the increase in negative sentiment has moved significantly downward. This decline is occurring even with corporate and high yield indices showing some tightening this last month. The survey was conducted in June, but the tilt is strong. This bias should be included in any portfolio adjustments.
“We need to embrace the fact that we don’t know what the next bad outcome is. We need to think outside the box.”
“The world is continuing to change, and we need to constantly reinvent ourselves in this revolving world.”
-John Williams, President NYFRB
Hedge fund returns for July were generally negative with the only exceptions being equity hedge and fundamental value strategy indices. The class of uncorrelated hedge funds styles, event driven and special situations, under performed. Defensive styles like systematic CTA and global macro also posted negative returns.