All posts in category: Bear Markets (12)

Timing the Market Successfully

Friday, September 1st, 2023

Modelling the behaviour of risk-seeking investors

For some time, we have been interested in the behaviour of risk-seeking investors, which we model using a variant of our standard approach, called a pro-risk momentum model. We find that it can be used to time switches between cash and US equities, so that our model outperforms US equities on a standalone basis over the last 50 years. This is a result which most academic research regards as unachievable. In absolute terms, the quantum of outperformance is not material, but the risk-adjusted returns are clearly superior and the drawdowns are significantly smaller and shorter. We find that the same approach also works when combining US 10-year Treasuries with cash and a broad commodity index with cash.

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China on the Brink

Friday, August 18th, 2023

Who is exposed in Europe and the US

We don’t know if there will be Lehman moment in China, but we are fairly confident that there is a major discontinuity coming soon: either a collapse of consumer and financial confidence or a series of stimulus measures, which will kick the can further down the road – a bit like the Eurozone crisis of 2011-12. We can’t forecast the outcome, but we can work out which companies and sectors in the US and Europe have the greatest revenue exposure. In general, more European companies have a modest 5% exposure to China, but if we take the threshold of concern as 10% of sales, the US has more exposure than Europe. The big exposure is US Technology where 65% of market capitalisation has more than 10% of sales in China, Hong Kong or Taiwan.

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Triple-Leveraged Cash

Friday, April 21st, 2023

With apologies to Bloomberg Surveillance

Most institutional investors are not allowed to use leverage in their portfolios, which is a pity, because one of our models, which switches between a 100% leveraged portfolio of US equities and cash, has outperformed the S&P500 since inception in 1996. It has exactly the same as inputs and rules as all our other asset allocation models and it produces better absolute and risk-adjusted returns than 100% equity exposure, with a smaller drawdown. It also beats our equity/bond model, but is not as risk-efficient. This disproves the theory that investors cannot use timing to beat the market. They can, if they have a margin account, and know how to use it. For most of the last 30 years, this result could be dismissed as a curiosity because a mixed equity/bond portfolio did so well. In particular, bonds rose when equities fell. But if equity and bond returns stay positively correlated – as they currently are – for an extended period of time, institutional investors may need to explore the opportunities created by cash and leverage strategies.

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Some Safety Plays May Not Work

Friday, April 7th, 2023

Positive correlation between equities and bonds still a threat

The top-down consensus is rightly gloomy about the outlook for earnings estimates and equity benchmarks in the US. The problem is that the market shares this analysis and still refuses to go down. We need an additional catalyst to shake us out of the current trading range. A mild US recession is not the main risk to balanced portfolios, provided bonds rise while equities fall. What we worry about is a bear market in everything, if the current regime of positive correlation between equities and bonds continues. There are ways to mitigate this, by lowering the beta in your equity portfolio, increasing exposure to Europe (and anywhere else that may benefit from a weak dollar) and increased exposure to cash and money market funds.

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Santa’s Merry Massacre

Friday, December 2nd, 2022

What Santa gives the New Year can take away

Recent strength is US and global equities is entirely consistent with normal seasonality, particularly the outperformance of the Eurozone. If normal seasonal patterns prevail, we would expect many of the recent trends to reverse in the New Year as follows: US equities will give up recent gains, Eurozone equities will underperform, US Technology will suffer further declines and the US dollar will strengthen once again. All of this would be consistent with normal seasonality, as is our new call that the bottom of the bear market will not come until Q3 2023 at the earliest.

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Bear Market Sector Strategy

Friday, November 4th, 2022

What to focus on and what to ignore

It easy to be overwhelmed by the speed and quantity of information in a bear market. Investors need a clear focus on what matters and what doesn’t. In any bear market, there are about 10 sector pairs (out of 45) which really drive the performance of a regional equity portfolio and the rest don’t matter very much. These pairs vary from one bear market to the next but are relatively easy to identify. There is also another set of pairs, which may be significant in market cap terms, whose relative performance cannot be easily integrated with the rest of the portfolio. US sectors which feature heavily in this list in this bear market include Financials, Healthcare and Industrials. In Europe, they are Materials, Utilities and Financials.

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Timing the Turn

Monday, October 17th, 2022

Think like a hedge fund with a short-equity position

At the bottom of every bear market, there is a moment when equities turn, but most long-only managers are too risk-averse to believe it. Our approach does not try to anticipate this, but there are techniques we can use to spot the opportunity sooner. The trick is to think like a hedge fund manager with a short position in equities. In every bear market since 2000, the window for a risk-efficient short position in equities has opened weeks or months after our long-only models have got to an underweight position. This window also closes well before our long-only model rebuilds its position in equities. At the bottom of the cycle, the marginal buyer is the person with a short position.

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How Earnings Recessions Behave

Friday, June 10th, 2022

Consensus estimates aren’t reliable in a bear market

Bear markets can make the most rational of investment approaches look pretty stupid. Any concept of fair value based on consensus estimates can be downright dangerous. The typical delay between the peak in the index and the peak in estimates is more than 30 weeks, so we should not expect the consensus to start cutting until late August.  The typical drawdown in 12-month forward estimates lasts between 115 and 170 weeks. So, the estimates you are using for 2022/23 may also be the numbers for 2025/26.

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Don’t Forget the Skew

Thursday, November 29th, 2018

Plan for falling equities with violent changes of direction

Although our models are consistently bearish about the outlook for equities, we agree that there are several large problems which have depressed performance, which would allow the market to bounce if they were “solved” – even temporarily. Rather than prepare for an outright bear market, we think investors should focus on the bull/bear skew and sell countries which tend not to perform in rising markets, even though they are heavily exposed when they fall. This list includes several large Anglo-Saxon markets such as the UK, Canada and Australia.

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No Yellow Flags

Thursday, October 26th, 2017

Sector dynamics of early bear markets

A large rise in excess volatility (equity volatility minus bond volatility) is a good indicator of the onset of a bear market in the US and elsewhere. It also works at the sector level for those sectors which peak early, before the dynamics of contagion take over. Every bear market is different, but there are similarities in the early phases. Apart from Telecom, which is a very small sector, there are no warning signs at the US sector level at the moment.

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