"Where are we in the business cycle?" is a question macroeconomists often are asked by investors. On the face of it, it is a reasonable question. The macroeconomic backdrop is an important input variable for key asset allocation decisions such as whether to be over- or underweight stocks relative to bonds, sector rotation, not to mention FX and credit positions. The question invites the idea that economic expansions are on the clock. They are in the sense that their average length is a question of a relatively simple empirical exercise. But a classic truism still remains. "Economic expansions don't die of old age, they're killed by economic policy", a phrase I have adapted from the U.S. version ending with the idea that economic expansions usually are killed by the Fed.
Read MoreIt’s been a while since I updated these pages, mainly because I have recently moved across the country, back to the Big Smoke, where I am now nestling in the hopefully up-and-coming part of southern London. I will be up and running with my market updates and videos soon enough, but first things first. I have been sitting on this piece, mentally more than anything, for a while, and I thought it would be a nice way to re-start my posting. I have long been thinking about whether it is possible to provide a good quantitative argument in favor of the defunct value equities, or more specifically the value “factor”. I think it is, but as always, I leave to you to judge. In my last post before my temporary hiatus, I made the argument that the vast majority of investors are structurally short volatility. Accepting this premise raises the obvious question; how does one achieve a cheap and effective long vol position? In this post I will try to offer a concrete and quantitative perspective on this question using the simplest tools available to us from finance theory. Before I get to that, though, I want to state the problem more precisely. In a nutshell, the traditional 60/40 portfolio is doing too well. The increasingly concentrated leadership in equity beta centered around the ubiquitous growth factor—essentially U.S. technology firms—and the correlation of this position to the performance of government bonds—driven by structurally falling interest rates—has been a boon for investors. A 60/40 portfolio with a concentration in growth stocks has increased by a factor of almost 4 since 2010, beating the MSCI World by almost 25%, not to mention breezing past the main regional indices—MSCI EM and MSCI Europe—by a factor of 2-to-2.5. That’s great news, but it also puts investors in a bind. If a balanced portfolio is winning on both legs what happens when the tide turns?
Read MoreOne of the main tenets at this space has been to cut away the extremes in your [equity] investing strategy. There are those who see market tops and imminent crashes everywhere, and then there are those who believe debt-financed share buybacks and dividend payments can continue to propel the market higher forever. They are both wrong, but the persistence of these two narratives and their interaction has been a key story in this cycle. It is my firm belief that the oscillations between these two positions have created a huge middle ground, which allows investors to make money. In the peanut gallery we talk about "sector rotation," but it's more than that. It's also about different themes which cut across traditional equity sectors and allow for price movements of key industries—even country indices— in opposite directions. I suspect most market geeks would be able to agree on this over a pint in the pub. But can we quantify it?
Read More