The January Effect

Wednesday, December 20th, 2023

Hangover or Party On

US investors have enjoyed a year’s worth of returns in seven weeks. This has been a rally of everything – except oil. Even real estate has had its moment in the sun. US Equities are approaching overbought territory and will probably get there by the end of December. US Treasuries – long and short – will get there in January, at the current rate of progress. But US and European credit is already there. There has to be some sort of reaction to recent strength. We expect credit markets to weaken first, which will be used to justify the recession narrative, which will then impact equities. Government bonds may continue their rally for a while, but we think the big theme for the year will be the US budget deficit. Round 1 is in January, the next one is in Q4. Bond vigilantes are not dead, just sleeping.

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Stall Speed

Monday, October 23rd, 2023

US equities may be on the verge of a short-term correction

One of our key indicators for US equities is flashing amber. The recommended weighting when compared with a portfolio of 10-year Treasuries and cash has fallen to a level where it historically continues down to zero more often than not. This could be accomplished by a correction in equities or a rally in bonds – very probably a mixture of both. However, we are more optimistic about the medium-term future. We don’t think this correction would indicate an upcoming US recession. It’s very difficult to have one, when the Federal budget deficit is over 6%. In our view, the correction in equities is a necessary pre-condition for putting a short-term floor under the Treasury market.

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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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No Longer the Cornerstone

Friday, February 17th, 2023

Cash is the new risk-free asset

Using the word “risk-free” to describe an asset which has fallen by some 20% during the course of the last two years, would offend most ordinary users of the English language. But finance professionals are still happy to do this when talking about long-dated government bonds. 10-year US Treasuries have failed to hedge the decline in US equities and the same is true in the Eurozone. Worse still, tactical allocation models based on this relationship have under-performed their benchmarks, removing the possibility of generating any alpha from market timing. All these problems go away as soon as we use cash instead of government bonds. It has higher absolute returns than bonds in the US and the Eurozone and the new models outperform their benchmarks with lower drawdowns and better risk-adjusted returns. It’s time for a rethink.

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Eight Non-Consensus Views

Monday, December 19th, 2022

A bearish consensus can still be complacent

We agree with the idea that US equities are going to suffer in the New Year, but disagree with many of the assumptions surrounding this view. We think US Treasuries are behaving like a risk-asset and cite their current elevated volatility as evidence. We highlight the positive correlation between equities and bonds, which means that there we may well repeat the bear market of everything we saw in H1 2022. On this basis, the dollar strengthens temporarily and the trough in equities is delayed till Q3. When the recovery comes, sectoral and geographic leadership in equities in likely to change and China will be a much bigger part of the story than Western investors currently imagine. The outlook for oil is anyone’s guess, but it will influence inflation expectations and generate bursts of volatility in all markets, contrary to its current benign behaviour.

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Upside Protection

Monday, November 21st, 2022

The need to hedge against unexpected good news

Our models are slightly conflicted at the moment. The multi-asset models, which mimic sophisticated institutional portfolios, are significantly more bearish than our simple equity vs government bond models, which are more retail-orientated. Before we dismiss the latter is just being wrong, we should at least try to explain the difference. Retail investors may be trying to hedge against the possibility of unexpected good news: a shallow US recession; a peace deal in Ukraine; or an end to zero-Covid in China. Any one of these could result in significant upside for global equities and the joint probability that none of them will happen is lower than you think.

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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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Something Is Going to Break

Friday, May 13th, 2022

Volatility has entered the danger zone.

Realised volatility continues to march higher every week and we have now got to the danger zone, where this creates the conditions for more volatility – especially if the FOMC is committed to much tighter monetary policy. In these circumstances, traditional valuation metrics lose a lot of their power and investors should assume that markets in one or more major asset classes will become disorderly. We think this has already begun in Nasdaq, Italian government bonds and the Chinese yuan. Other assets, which may follow in due course, include US High Yield, credit ETF’s and US housing.

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Back to the 1870’s

Friday, April 1st, 2022

150 years of beating the benchmark

We have recently achieved one of our most cherished ambitions – to test our process against a truly long-run data set and see if it works. The answer is a very definite yes. Our standard process beats US equities, US Treasuries – and any fixed combination of these two – on all of the three most important tests: highest absolute return, most risk-efficient return and smallest drawdown. The test covers 150 years, including two world wars and multiple bear markets. The outlook for the world is impossible to forecast at the moment, so we find it very comforting that a systematic data-driven approach can do so well

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Approaching a Turn in USD

Friday, December 10th, 2021

The consensus for a strong dollar is more fragile than it appears

Our asset allocation models have been significantly dislocated by the strength of the US dollar. Our previous note – Currency First Is Second Best – showed that we had a model for working round the problem, even if it was difficult to know when to use it. This note introduces our G7 currency model, which we have been live-running for about two years. We don’t use it to make trade recommendations because we think the risk-adjusted returns are normally unattractive compared to those in other models, but it is occasionally useful in times of extreme market stress. The model itself is based on a mean-reversion approach and it is now close to its largest underweight position in USD over the last two years. This time last year, it was close to a two-year maximum overweight, when the consensus view was the dollar would be weak in 2021. If we were forced to commit capital, we would position for a weaker USD, but we think the right time to do this is January, not December.

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