Navigating complex market conditions with global perspective and local insights: Despite market rallies, many investors underperformed due to the unexpected nature of economic cycles. Global perspective and local insights can help navigate such conditions.
The last year brought an unprecedented economic cycle, compressing a crisis and recovery into a few months. This speed and unexpected nature of events left many investors underperforming despite headline-making market rallies. Principal Asset Management, with its global perspective and local insights, helps navigate such complex market conditions. Meanwhile, empathy and awareness towards invisible struggles, as discussed in the Visibility Gap podcast, can benefit individuals and organizations alike. In markets, there's a sense of dissatisfaction with the market's performance, as certain sectors and stocks have seen disproportionate gains. Even well-positioned investors might have missed the quick recovery, and professional investors' expectations were often not met.
Trend following strategies underperformed in 2020: Theoretical benefits of trend following strategies were challenged in 2020, raising questions about future adjustments to portfolio strategies for risk management and diversification
Trend following strategies, which aim to profit from the continuation of market trends, did not perform well during the unprecedented market reversals in 2020. Corey Hofstein, CIO of Newfound Research, discussed how their trend following equity strategy underperformed last year, as they had expected given the fast market reversals. However, the failure of this strategy to protect against significant drawdowns raises questions about the future and potential adjustments to portfolio strategies. Theoretically, trend following strategies can provide a premium by acting as liquidity providers in futures markets or by exploiting risk limits during market stress periods. But the 2020 market behavior challenged these assumptions, and investors may need to reconsider their approach to risk management and diversification.
Firms' nonlinear response functions create trends during market stress: Firms' responses during market stress can create trends, but during sell-offs, they derisk, leading to procyclical trends. Hindsight suggests changes, but sticking to a mandate and legal constraints limit nimbleness.
While markets may appear random, firms' nonlinear response functions during periods of market stress can create trends. These trends can be exploited for risk management, but during market sell-offs, firms are forced to derisk, leading to a procyclical trend. During the sell-off in March 2020, the speaker's portfolio saw a buffer against the S&P 500 drawdown, but the delay in trend signals turning positive led to a significant delay in re-entering the equity market. The speaker acknowledges that hindsight suggests changes could have been made, but as a portfolio manager, communicating and sticking to a specific mandate and potential legal constraints make it challenging to be nimble in an exceptionally quick market sell-off and recovery.
Legal obligations and restrictions impact portfolio management during market extremes: Understanding market dynamics, roles of players, and regulatory considerations are crucial for effective portfolio management during market extremes
Managing a portfolio, especially when it involves other people's money, comes with legal obligations and restrictions that can hinder the ability to make necessary changes even during market extremes. This was evident during the rapid market unwind in March 2020, where trend following strategies, which typically work during extreme periods, faced challenges due to the speed of the market's movement and the regulatory hurdles involved in making changes. The inability of certain players to adapt quickly created a cascading effect, exacerbating the market downturn. This highlights the importance of understanding the market dynamics and the role different players have, as well as the structural and regulatory considerations that can impact investment strategies.
Human element plays a crucial role in trend-following strategies: While historical data guides investment strategies, human experience and memory add value in unexpected situations, but can also introduce biases. The balance between human and systematic elements depends on the strategy and investor's risk tolerance.
While historical data is essential for investment strategies, it may not be sufficient to prepare for unexpected events like the financial crisis. For trend-following strategies like the one discussed, the data itself may not contain the necessary information, but the human element, specifically the experience and memory of the portfolio managers, plays a crucial role in designing the strategy and setting relevant constraints. The human element can bring value by allowing for idiosyncratic decisions and adapting to unprecedented situations. However, it can also introduce behavioral biases. The distinction between systematic and discretionary managers lies in who retains the optionality to adapt to idiosyncratic environments. The former sells that optionality to collect a premium by avoiding behavioral biases, while the latter retains it to adapt to changing markets. Ultimately, both approaches have their advantages and disadvantages, and the optimal balance between the human and systematic elements depends on the specific investment strategy and the investor's risk tolerance.
Central banks' actions shaping unexpected market behaviors: Central banks' long-term fixed-dollar liabilities push investors up the risk curve, market microstructure shifts, investors adopt volatility contingent strategies, creating a self-reinforcing loop in markets.
Central banks' actions have influenced markets in unexpected ways, leading to a self-reflexive relationship between the two. This relationship can result in feedback loops that deepen in the financial system, as seen in the treasury trades that blew up in March and affected the equity market. After observing market behavior during the pandemic, the author identified several interconnected narratives shaping markets today. Central banks have shifted from referees to active players, pushing investors up the risk curve to pursue yield due to their long-term fixed-dollar liabilities. Market microstructure has changed, with a move from active to passive investing and the rise of concentrated high-frequency trading, which provides liquidity through fewer players. Investors have adopted volatility contingent strategies, increasing their leverage and bidding for equities, resulting in suppressed volatility. These interconnected trends create a loop that can be challenging to identify where it starts or ends.
Central Banks' Role in Market Stress: Central banks' liquidity injections can perpetuate market cycles, making it challenging for professional managers to generate alpha and for markets to operate independently.
The relationship between the financial markets and central banks has become more interconnected than ever before. The procyclical nature of equity markets, combined with the need for large institutional investors to meet demand and maintain liquidity, can result in a "violent unwind" during times of market stress. Central banks' efforts to inject liquidity back into the market can perpetuate this cycle. The influence of systematic strategies, such as target date funds, further exacerbates this trend by making markets less responsive to fundamentals and more sensitive to flows. This "flows before pros" dynamic may leave professional investment managers feeling disgruntled, as they struggle to generate alpha in a market dominated by momentum and central bank intervention. Ultimately, the central bank's role in supporting the market may make it difficult for the market to stand on its own.
Central banks' challenge in withdrawing from markets rapidly: Identify potential pressure points in the market and exploit them during central bank interventions, while leaning into momentum and upside convexity, and adapting to markets' increasing speed and volatility.
Central banks are finding it challenging to withdraw from markets rapidly due to the potential market disruption caused by rising interest rates. The world is becoming more tail risky, and market stresses are becoming more important for central banks. Investors can attempt to identify potential pressure points in the market and exploit them, assuming a central bank intervention. This strategy can be thought of as a game of musical chairs, where identifying fault lines and positioning oneself on them can yield opportunities. However, it's essential to lean into momentum and upside convexity while not leaving oneself naked on the downside to create an asymmetric profile. Ultimately, markets are moving further and faster, both on the melt-up and the meltdown, and investors need to adapt accordingly.
Managing client expectations during market changes: Maintaining strong client relationships, transparency, and flexibility are crucial in adapting investment strategies to meet evolving market conditions, especially in the ESG and green funds sector where retail investor flows and speculation can cause price volatility.
Market trends, particularly in the ESG and green funds sector, can be heavily influenced by retail investor flows and speculation. This can lead to price volatility and the need for adaptability in investment strategies. Principal Asset Management emphasizes the importance of maintaining strong client relationships and open communication, especially during times of market change. Transparency and flexibility are key in managing client expectations and adjusting investment strategies to meet evolving market conditions. While it's impossible to predict when rules may no longer function as expected, maintaining a long-term focus on flexibility and adaptability can help investors navigate the complexities of the market and maintain a competitive edge.
Balancing Systematic Strategies and Discretion: While systematic strategies are popular, discretion is still important in volatile markets. Firms like Corey's use a mix of both, allowing for flexibility in options trading while maintaining systematic tilts.
While the trend in investing has been towards systematic strategies, there are still areas where discretion is necessary, particularly in market environments with rapid changes and high path dependency. Corey discussed how his firm implements systematic strategies in certain areas, such as stylistic tilts, but allows for discretion in others, such as options trading. The Fed's role in suppressing volatility and the resulting risk-taking behavior was also mentioned as a recurring theme in many investment conversations. However, it was suggested that this situation may be linked to economic policies that deprive the private sector of the income needed for a sustainable economy, leading many people's fortunes to be tied to asset markets rather than GDP. Overall, the discussion emphasized the importance of striking a balance between systematic strategies and discretionary decision-making in various market conditions.
Flows vs Fundamentals: Understanding the Disconnect: Retail traders, who sense market inflows and momentum, can outperform professional investors during market rallies despite economic downturns.
Last year, many individuals and financial professionals expressed a disconnect between the economic downturn and the stock market rally, leading to a sense of dissatisfaction. This disconnect can be attributed to the phenomenon of flows versus fundamentals, where the retail trader, who may have a better sense of market inflows and momentum, can outperform professional investors. This disparity was particularly noticeable during the market rally following the economic downturn in 2020. The conversation also touched upon the idea that many investors, both professional and retail, were hesitant to re-enter the markets due to disbelief in the market's ability to rally amid such an economic downturn. Overall, this phenomenon highlights the importance of understanding market dynamics and the role of sentiment and momentum in driving market movements.
The Important Lesson a Quant Manager Learned in 2020
Recent Episodes from Odd Lots
The Next Stage of the Credit Cycle with Oaktree’s Poli
This week, the Fed cut benchmark rates by 50 basis points. Lower financing costs should be a relief for companies that need to borrow in the form of bonds or loans. But, the weird thing about the previous few years of high rates and high inflation is how much corporate credit has defied expectations. While defaults increased slightly, there wasn’t a huge wave of bankruptcies. And most companies haven’t really had trouble finding financing, with a smorgasbord of options available to them — including from the booming private credit market. So what happens now that the Fed is lowering rates? In this episode, we speak with Danielle Poli, co-portfolio manager of Oaktree’s Diversified Income Fund and a founding member of the firm’s investment committee, about how she sees the next leg of the credit cycle unfolding, and how she decides between a multitude of potential investments in the space.
Related Links:
The Black Hole of Private Credit That’s Swallowing the Economy
The Hottest Way for Banks to Get Risk Off Their Balance Sheets
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Pimco CIO Dan Ivascyn on the Biggest Fed Decision in Years
It’s Fed Day, and while everyone expects the central bank to cut benchmark interest rates, the key question is by how much? Will it be 25 basis points or 50? Investors are evenly split between the two possibilities, setting up one of the most uncertain meetings ever. So what does a big bond manager do on a day like this? In this episode, we speak with Dan Ivascyn, Group CIO at Pimco, where he manages the $158 billion Pimco Income Fund. He tells us what he’s expecting from the FOMC, and what he’s seeing in terms of financial conditions and the real restrictiveness of the monetary environment right now. He also walks us through what Fed day is actually like at Pimco, where he thinks the economy is going, and answers the question of whether — with rates finally going down — bonds might be back in favor.
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How Josh Brown Created A Financial Media Empire
15 years ago was a pivotal moment for financial media. On the one hand, we were in the midst of a huge financial crisis, which shook everything up and exposed how little we knew about our own world. In addition to that, we were in the early moments of a revolution, which saw the rise of blogs, podcasts, "Finance Twitter" and other new platforms for disseminating information about markets and business. One of the winners from that era was Josh Brown, a former stockbroker who rose to fame in part on the back of his must-read blog The Reformed Broker. Now he's the CEO of a large investment advisory firm, Ritholtz Wealth Management. He's got a popular podcast. He's got a new book. He's a fixture on CNBC. And he even has a conference business. We talk about his career path, what he's learned, some funny stories from the good old days, and how he became a media giant.
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Security, Bookmarked: Finance (Sponsored Content)
Financial institutions have been a leading target for cyber crime since the dawn of the internet. But phishing schemes have become far more intricate, and cyber heists go beyond stealing money from a bank. JF Legault, Deputy CISO at J.P. Morgan Chase, explains how he leads cyber defense on the front lines of work — and lays out a strategy to transform teams into early detection networks. Then David Adrian from Chrome unpacks how web browsing protections, robust monitoring, and a real-time view of threats can fit into this kind of strategy to maximize resilience to a cyber attack.
This episode is sponsored by Chrome Enterprise.
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Lots More With Isabella Weber on Draghi's EU Competitiveness Report
This week, former European Central Bank President and Italian Prime Minister Mario Draghi published a long-awaited report examining ways to make the European economy more competitive. The report comes at a time when there are major concerns about how Europe is stacking up against the US and China in things like electrical vehicles and AI. It also dovetails with long-running debates about German fiscal austerity, economic tensions between various European Union members, energy crises, and inflation. In this episode, we speak with University of Massachusetts-Amherst economics professor Isabella Weber about her takeaways from the report and potential policy approaches to solving Europe's big competitiveness problem.
Referenced in this episode:
Draghi Says EU Itself at Risk Without More Funds, Joint Debt
Draghi’s Call for Joint EU Bonds Hits Wall of German Opposition
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Adam Tooze on the Big Misconceptions of the Chinese Economy
One of the big buzzwords over the last year or so has been "overcapacity." There's a constant line of argument that China is unfairly flooding the world with unprofitable goods and creating huge, unsustainable imbalances. Western countries, particularly the US (but also Europe), have responded by raising tariffs and engaging in domestic industrial policy in order to compete. But is the strategy sound? Are the basic premises of the problem correct? On this episode of the podcast, we speak with Columbia Professor Adam Tooze, the author of several books, as well as the popular Chartbook newsletter. He argues that the overcapacity framing is misguided, and that the US may be making a mistake putting its chips down on an industrial revival. He talks us through some of the actual weaknesses of the Chinese model, as well as its global political reverberations.
Read more:
Two Veteran Chip Builders Have a Plan to Take On Nvidia
The US and China Are in an All Out Race for AI Domination
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US Trade Rep Katherine Tai Describes the New Era of Globalization
One of the rare areas of bipartisan consensus in the US right now, is on the need to change our trading relationship with China. Former President Donald Trump started a process of putting tariffs on Chinese goods and limiting the export of certain key technologies. This has only expanded under the Biden administration, with expanded restrictions on things like electric vehicles, solar panels, and semiconductors. So what's the thinking behind this drive? What are the goals and what are the risks? On this episode we speak with the United States Trade Representative Katherine Tai. Ambassador Tai describes what she sees as a rethink, or a new version of, globalization. She explains the new worker-centric priorities, how trade fits into domestic investments, and what a healthy version of international economic relations actually looks like.
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The Booming Crypto Use Case That's Happening Right Now
Pretty much since the moment that cryptocurrencies came into existence, there's been a chorus of skeptics who argue that they solve no real world use cases, except for gambling and speculation. For a while, there was a lot of hype about things like Web3 or DeFi, but for the most part, these still remain in the realm of pure speculation and gambling. And so, the ultimate use case for crypto remains elusive. Our guest on this episode argues otherwise. He thinks that stablecoins, such as Circle or Paxos, which are backed by actual dollar instruments in regulated institutions running on public blockchains (like Ethereum or Solana) are solving a genuine problem in transmitting money, beyond just speculating on other cryptocurrencies. Austin Campbell is an adjunct professor at Columbia Business School and the founder of Zero Knowledge Consulting. He also comes with a long resume at both crypto and legacy financial institutions. He explains why stablecoins are having a moment and explains the problems they currently solve (particularly internationally) and why legacy payments infrastructure is unlikely to serve the same needs.
Read more:
The Case for Stablecoins Being the New Shadow Banks
How Stablecoins Became a Powerful Force in Crypto
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How Hedge Funds Discover the Next Superstar Trader
One of the problems in investing or trading is that — to use a common disclaimer — past results are no guarantee of future success. Someone can have a great track record in their stock picks, but maybe they just got lucky. Or maybe they were particularly well-dialed into one market regime that inevitably shifts. Or maybe they're actually just better than other traders. For multi-strategy hedge funds or "pod shops," there's an ongoing battle to hire or train the next great portfolio manager. But how can managers tell who is actually good and who isn't? On this episode of the podcast, we speak with Joe Peta, who was previously the head of performance analytics at Point72 Asset Management and has had a long career in the trading world. He's also an avid fan of sports gambling, and the author of the recent book, Moneyball for the Money Set, which attempts to take some of the talent analytical principles that originated in Major League Baseball and apply them to evaluating portfolio managers. He talks us through the traditional approach funds use to find or create superstars, and how these approaches can be improved upon using more rigorous, quantitative methods.
Mentioned in this episode:
Hedge Fund Talent Schools Are Looking for the Perfect Trader
How to Succeed at Multi-Strategy Hedge Funds
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The Black Hole of Private Credit That's Swallowing the Economy
There's been a lot of talk about private credit in recent years. The market has exploded in size, and there are worries that it could be a bubble that eventually bursts and sparks disaster. But there are other negative effects from private credit that might already be happening. In a new paper called "The Credit Markets Go Dark," co-authors Harvard Law School professor Jared Ellias and Duke University School of Law professor Elisabeth de Fontenay argue that the $1.5 trillion market for private credit is already having a big impact on the economy — and not in a good way. They say that the rise of private credit marks a seismic change for corporate governance and dynamism.
Read More:
Odd Lots Newsletter: The Black Hole of Private Credit
Private Credit Pushes Deeper Into Risk That Wall Street Is Fleeing
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Related Episodes
No recession – China’s economic inertia – Natgas bounce
With CI Markets, you can access AI-powered market forecasting for as low as $20 a month. Get 94.7% market forecast accuracy for over 1200 assets across stocks, commodities, currencies, equity indices, and economics.
In the latest episode of "The Week Ahead," Tony Nash hosts David Cervantes, Albert Marko, and Tracy Shuchart, offering valuable insights on recession indicators, China's economic challenges, the natural gas market, and Europe's energy supply problems.
Key themes:
1. No recession
2. China’s inertia
3. Natgas bounce
Key takeaways:
- Accurate recession call by David Cervantes, emphasizing construction activity and employment data.
- Limited impact of commercial real estate in the broader economy.
- Tech job losses not supported by data; payroll and claims data refute significant losses.
- Trend of individuals turning to DIY solutions for home repairs.
- Dismissal of concerns about a credit contraction in the banking sector.
- Exploration of potential energy shocks and their impact.
- Concerns about China's lack of political and economic movement, despite slight retail sales growth.
- Geopolitical considerations and parallels between China's situation and Japan's experience in the 1980s.
- Challenges faced by China, including demographics, environmental issues, and water scarcity.
- Impact of high energy costs and environmental policies on European industries.
This is the 69th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Follow The Week Ahead panel on Twitter:
Tony: https://twitter.com/TonyNashNerd
David: https://twitter.com/pinebrookcap
Albert: https://twitter.com/amlivemon
Tracy: https://twitter.com/chigrl
Watch this episode on Youtube: https://youtu.be/Trd9pE_GNOU
Will Bitcoin Replace Gold? w/ Peter Schiff | PBD Podcast | Ep. 393
Patrick Bet-David, Tom Ellsworth, and Brandon Aceto are joined by Peter Schiff. Peter David Schiff is an American stockbroker, financial commentator, and radio personality. He co-founded Echelon Wealth Partners in Canada. He is involved in other financial services companies including Euro Pacific Asset Management, as an independent investment advisor, and Schiff Gold. HARTFORD GOLD:
- Protect yourself against Central Bank control with - American Hartford Gold: https://bit.ly/3QzMjHd
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The US dollar loses its crown
The dollar dominated last year as the US Federal Reserve raised interest rates quicker than other countries to tame inflation. But the so-called “king dollar” has shifted recently. FT Capital Markets Correspondent Kate Duguid dives into how the greenback has been toppled from its throne and what that means for the rest of the world.
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For further reading:
US dollar hits reverse gear as Fed cedes rate-rise ‘driver’s seat’
Dollar touches 7-month low as Fed rate rise expectations slide
The downturn in the dollar is not just about rates
Emerging market governments raise $40bn in January borrowing binge
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On Twitter, follow Kate Duguid (@kateduguid) and Michela Tindera (@mtindera07)
Read a transcript of this episode on FT.com
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Why Do Most Countries Have Their Own Currency? Governments Wanted It That Way.
Even when currency is backed by gold, governments have many political reasons to pursue national, territorial currencies. Now there are hundreds of national currencies. It didn't have to be this way.
Original Article: "Why Do Most Countries Have Their Own Currency? Governments Wanted It That Way."
The Dollar Crisis of 1861–1865: Greenbacks, Gold, and Confederate Dollars
Recorded at the Mises Institute Supporters Summit in Auburn, Alabama, 12-14 October 2023.
Sponsored by Scott and Cathy Ullery.
Download the slides from this lecture at Mises.org/SS23_PPT_15