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The Fed and other central banks are not that important in the current thinking of investors. The focus is not on the policy musings of bankers but the real economic data. All that matters is whether growth has a strong chance to be above trend and whether global DM inflation has a chance of reaching and sustaining 2%. We are skeptics of both occurring.

The Tax Foundation map of state funding ratios for public pensions is very sobering. The amount of state under-funding is significant. These numbers are determined by the discounted expected liabilities relative to the assets held. To stay even with these ratios and assuming there is no surprise increase in liabilities, the states have to return the discount rate. These discount rates or expected returns seem unrealistically high.

Going into the month, there are good up trends in place with global equities and down trends in oil, precious metals, and selected commodities. What is interesting is the inconsistency across some markets sectors. The reflation risk-on trade is still apparent in the global equity indices, but we are not seeing strong evidence of bond sell-off or rally. Oil prices suggest both supply strength and demand weakness. Gold and precious metals are out of favor with long-only investors. The idea that we will have a dollar rally on Fed hikes seems misplaced and there is less risk-on demand for the US relative to the rest of the world.

No hedge fund strategy will make money all of the time. As the market and economic environment changes, the performance of different strategies will also change. Hedge fund factor exposures will be different based on the strategy employed by the manager. If you cannot predict the environment factor exposures, there is value with holding a diversified portfolio of hedge funds. April performance clearly shows the difference in strategy behavior.

The SocGen CTA index was essentially flat for the month which is not surprising given three major factors. One, we are in a global risk-on environment which generally is not attractive for trend-followers. It is not that there are no trends, but there were limited gains from diversification across asset classes relative to a risk-on portfolio. Two, there were few strong trends going into the beginning of the month. Given the usual time-frame for effective trend-following which is weeks not days, there has to be continuity of trends to have a good performance month. The strong gains in foreign markets may not have been given enough exposure to generate good portfolio returns. Three, the focus on financials especially fixed income and currencies by large managers was a drag on performance relative to equities and short commodities trends. Four, volatility is at extreme lows. We have looked at market volatility through the VIX index and current levels are above the 98th percentile for the lowest since 1990. Divergent strategies based on taking advantage of the spread in prices through time will be limited in their return potential in this type of environment.

I was reviewing an interesting research piece from Covenant Capital on kurtosis across different assets traded in the futures markets. They offer a spreadsheet tool that can allow anyone to find the number of fat-tailed occurrences relative to a normal distribution. The data show that there are fat-tails everywhere across all asset classes. We do […]

It is a risk-on world with global equities (EFA) and emerging markets (EEM) now posting double digit gains for the year. A first round French election that was pointed less in the direction of Le Pen and a Trump presidency that does not seem as extreme as some pundits suggested has been coupled with global economic growth that is stronger than expected. The deflation trade may be further tempered in the US, but the threat of trade wars has diminished and the world economy is more focused on reality than dire economic scenarios.

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.