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We have not heard from the “bond vigilantes” in quite some time. The origin of the word vigilante is Spanish for watchman, alert, or guard, and like a watchman they have been out there waiting for the long combination of events. The definition of bond vigilantes is a broad term for bond market participants who impose discipline on the market through focusing on negative fundamentals. Their form of discipline is selling duration or not buying at current levels.

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.

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.

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.