Many commentator have talked about the fact that stocks and bonds moved together during the current market sell-off as if this is big news, highly unusual and signal of market change. A positive correlation is not the normal relationship we have seen in the post Financial Crisis period, but it may be a little early to say there is a sea-change in market behavior.
Risk parity has had good performance over the last two years with double digit returns after stumbling in 2015, yet the diversification strategy of equal weighting of four major asset classes has been painful this year. Diversification based on weighting risks offers some protection but is not cure for a volatility revaluation.
The talk of the markets is the significant spike in the VIX index and the large decline in equities over the same period. An important question is whether the relationship between the stock and volatility has changed with this move. A quick answer is no.
When asked for money, WC Fields once said, “Sorry good man, all my money is tied up in cash.”
McKinsey and Company published an interesting paper on the use of AI in asset management called, “An analytics approach to debiasing asset management decisions”. (Hat tip to Tom Brakke for mentioning the article in his newsletter.) This paper shows the powerful use of analytical tools to extract hidden biases in investment management decision-making. Employing large data sets of manager decisions, companies are finding a wide set of behavioral biases identified in economics present with their decision-making.
Hedge fund performance, as measured by the HFR indices, showed strong performance in January especially for global macro and systematic CTAs. Systematic CTAs also generated returns that were in the top three categories for the last twelve months.
Equities started the year with strong performance across style, sector, and country groupings; however, there were some exceptions to these gains and also some signs of potential for performance declines. Bond ETF returns were all negative except for international bonds which gained from the dollar decline. These returns are consistent the fundamental story of strong growth and expected higher inflation. There will be peak and valley in return even with the clear story, but the general direction is still risk-on for equities and avoidance of duration for bonds.
Managed futures showed strong performance in January from a variety of asset classes. Many managers were able to continue to take advantage of the trend in US equities, albeit with a giveback of some profits at the end of the month. Global bonds generated gains from short positions as a significant sell-off accelerated through the month. The dollar decline made trading currencies also profitable. The trend in oil and refined products also continued although a surprise inventory increase at the end of month added volatility. Selective trading in precious and base metals also added to performance. There were also commodity opportunities from newly formed trends.
January performance was a good start to the year for many trend-followers. Our sector trend measures suggest a good performance month that looks to continue into February. The fundamental themes concerning growth and inflation at the beginning of the year continue although with different levels of intensity.
Arbitrage: Several sub-strategies fall under arbitrage. The most prevalent in the managed futures industry is statistical arbitrage. A simple example is simultaneously buying gold on one exchange (for a lower price) and selling gold on another exchange (for a higher price). This strategy looks to profit from the price difference. Average Commission: This represents the […]
With continued euphoria about global growth and growing fears of inflation, the large cap and international stock investors saw strong gains while bondholders were hit with loses. Markets in January saw extremes in what were identified as the core themes for the year, growth plus inflation. Now, there may be stagflation holdouts, but growth indicators are still strongly positive albeit there are signs that the trends in positive economic surprises last quarter will be more tempered.
The relationship between growth and equity market returns is not always direct. Equities can move higher because of an increase in earnings growth or from an increase in valuation. Market earnings should increase with economic activity but they may vary across the cycle. Similarly, the relationship between growth and nominal yields also can be variable albeit generally positive. Higher growth may lead to higher real rates, higher expected inflation or a change in monetary policy. The problem is that actual economic growth often has reporting delays so the link with market prices is mixed. The link between prices and fundamentals should focus on leading or forward-looking indicators.
No one wants to be the holding a bubble asset when the market breaks. It is not pretty given the potential for sharp corrections, but it is hard to say when it is time to leave the party. You could just say you don’t want to play the game, but the opportunity cost can be high because the time between bubbles begin and the market reverses can be measured in years. Additionally, with bubble language surrounding equity and bond markets as well as some real estate markets, the world could either be filled with bubbles or the term is being used so loosely that it does not have meaning.