Lower for Longer

Friday, June 24th, 2022

New worst-case scenario for US Equities

We have cut our reasonable worst-case estimate of where the S&P500 may bottom from 3,400 to 3,000. This follows on from our last note which argued that current consensus earnings were likely to drop by at least 15% before hitting their trough sometime in 2023. Our new target implies a forward pe ratio of about 15x, which is slightly lower than the median for this century.  As consensus forecasts are reduced, we expect the earnings mix to move away from highly-valued sectors like Tech and Consumer Discretionary towards lowly-valued sectors like Energy and Materials. The other reason for our new target is that nobody has any profits from other investments which they can reinvest into equities. US 7-10 Treasuries are down by about 17% since the equity market peaked, compared with gains of about 10% at the equivalent stage of the bear markets in 2001 and 2008.

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Normality Reasserts Itself

Friday, May 27th, 2022

Monetary policy distorted the mechanics of risk and return

The huge monetary interventions during the pandemic in the US and other countries were designed to protect equities from a surge in economic and financial risk. They succeeded, but at the cost of distorting the normal relationship between risk and return: specifically, the excess volatility vs the excess return of equities vs bonds. This is now reverting back to normal. As the volatility of equities rises relative to the volatility of bonds – and this figure is well below its long-run average, let alone its potential peak – their return relative to bonds must decline. The only developed market which may escape the worst of this adjustment is Switzerland.

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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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No Limits

Friday, January 21st, 2022

Scope for equity position sizes to get much larger

The start to 2022 feels so hectic partly because the end of 2021 was so boring. The active weight in our sector models – our proxy for the risk appetite of equity investors – was at multi-year lows all through December. We think it is now close to bottom and there is no technical reason why it could not rise strongly in coming weeks. An increase of 40% in position size would only take us back to bottom of the top quartile in terms of risk-budget utilisation. We also think that the narrative of rotating from growth to value is a little simplistic. Many of these moves can be explained simply by looking at changes in estimate momentum.

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So, You Want to Buy the Dip

Thursday, May 20th, 2021

Three rules for how to do it

Nothing in the last two weeks has changed our view that a correction in global equities is coming. If you are one of those investors who has waited all year to buy the dip, we have three rules about how to do it. One, decide your tactics in advance and don’t pay too much attention to the narrative behind the correction. Two, don’t add complexity to a market timing trade by using it to rebalance your equity portfolio. Three, if you want to front run a correction, make sure you have enough defensive exposure at a sector level. Our top pick here is European Telecom.

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Re-Configuring the S&P Sectors

Friday, May 29th, 2020

Time to Start Thinking About It

Well-designed sectors make portfolio management easier, but that means that the definitions need to be reviewed and refreshed on a regular basis. We believe we have arrived at that moment in the US. We propose splitting the Tech sector into two, combining Materials with Industrials and Energy with Utilities. We find that it is easier to generate systematic outperformance using the new definitions.

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Asia: First In, First Out

Thursday, March 19th, 2020

Already producing better risk-adjusted returns

The recent volatility shock is as big as the one in the middle of the GFC and it isn’t over yet. It has also happened three times faster, in three weeks rather than nine. Fear is inevitable, but the are some interesting opportunities, especially in Asia. Countries like Taiwan and South Korea have managed the corona virus better than the US or Europe, while China is already recovering. If you wait for the bounce in the West, you may miss it in the East.
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Chairman Mao is Coming to Dinner

Friday, February 7th, 2020

Or the fat lady is about to sing (choose your own metaphor)

Apple and Microsoft both look significantly overbought relative to US equities. Other US stocks with similar scores have underperformed by about 15% over the next three months. If this happens to the two largest stocks in the index, US equities will probably fall.

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Rhyming or Repeating

Thursday, August 15th, 2019

Our asset allocation models look like August 2018

Our asset allocation models suggest that we may be close to an episode when individual threats to equity returns combine to create a “super-risk”. These episodes are too complex to forecast with any certainty, because financial market participants will respond differently than they did a year ago, when we last saw this pattern. In the short term, investors should prepare to go to maximum underweight in equities.

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