testing

The market has shown new strength on slightly better economic data, increasing oil prices, and continued increased monetary liquidity, but care should still be taken with taking on more equity risk.  First, the threat of a recession albeit low is much higher than what we have seen in years. I have taken the St Louis Fed recession probability model estimates and changed the values to logs. This will place more roughness in the low probability numbers. It is nice way to look at the marginal changes in probabilities. The readings are certainly not close to Jim Rogers "100%" recession comment this week, but the threat is real and certainly more than what we have seen since the last recession.  Second, I look at the financial stress indices produced by different Fed banks. Below we show the Cleveland Fed numbers. That number shows a heightened level of stress although it looks like we have reached a local maximum. Financial stress is subjective and not part of the Fed's policy...

The demand for hedge funds continues. The recently released 2016 Credit Suisse hedge fund investor survey shows that over 80% of investors plan to maintain or increase their allocations to hedge funds this year. The survey also ranked the most popular hedge fund strategies as measured by their net demand. Equity market neutral filled the top two spots and equity long/short grabbed two of the top five positions. The only strategy that was outside of equity trading was global macro discretionary. I find this very interesting because equity market neutral is really an attempt to gain the risk free rate of return plus alpha. We know the risk-free rate is still hovering close to zero, so you need to chase alpha. More money will be looking for the same set of opportunities. Markets may not be efficient, but we do know they are competitive and that easy market entry into an inefficiency will drive excess returns lower. The only reason to invest in market neutral is that you believe that there...

Often times you will hear managed futures managers discuss the markets they made money in, but the really relevant issue is whether they were able to exploit trends in a sector. Trend-followers need to capture sector trends, or more bluntly, there have to be sector trends that managers can exploit. Hence, we have developed a simple table of sectors, their recent direction, and the macro signal that is coming from these prices.  We look at a trend indicator for each major market within a sector and average the simple direction signals to form a sector  up or down indicator to show sector trend. For example, we look at a set of stock indices around the world which show all are now in major up trends. For bonds, we look at all major global bond markets as well as the different futures markets along the yield curve. Here the story is mixed with US markets rolling over from their up trend but the EU continuing to trend higher.  We also discuss what the prices are indicating as...

Although US equities rallied in the second half of the month to almost get to flat returns for February, hedge funds in most cases were not able to generate positive gains. The exception was managed futures which generated strong monthly gains and easily beat other hedge fund alternatives. The only two other positive gainers for the month were global macro and special situations which is a catch-all category.  Hedge funds should not be expected to track short-term changes in equities or bonds. Their beta exposure is significantly less and in the range of .3 to .6 versus the S&P 500; nevertheless, during periods of poor performance hedge funds should be muting the loses. To a degree they have been doing that so far this year. The combination of January and February for the HFR Global Index and Equal Weighted Indices have outperformed an equity portfolio, but many individual strategies have simply missed the mark.  The managed futures and global macro indices were the only t...

The SocGen CTA index gained 2.89 percent for February and the SocGen Short-term Traders index posted an increase of 2.88 percent for the month. Both indices are solidly positive with 7.19 and 6.47 percent gains for the the year. Managed futures were able to post gains in spite of a reversal in equities to the upside and a stalled bond rally near the end of the month. Even with the reversal in equity fortunes based expectations of better US growth and continued monetary liquidity around the globe, US equities are down 5 percent for the year. The return differential between equites and managed futures is now double digit. This advantage is even greater for global equities. The Barclays Aggregate bond index is the most often used benchmark for institutional investors. Its returns are more muted than the long bond because of its heavy skew toward mortgages and credit. Managed futures is outpacing this key bond index by 5 percent. Long bond exposure would have done better over the last two ...

There are a number of reasons for holding international bonds. It will be some variation on diversification, but as yields have fallen the risks have changed.There is no yield cushion, so investors are making a directional view on rates and currencies. If you don't have a view, there is no reason to hold international bonds. Look at the Bloomberg Sovereign Developed Bond index ex US as a simple benchmark. The current yield to worst is 45 bps compared with the index yield with US bonds of 72 bps. Investors are losing close to 30 bps by going outside the US. The OAS to US Treasuries is 22 bps for a portfolio of AA- credits.   A table of yields since 2010 at the end of February compared with the dollar index volatility for 100 days shows a decreasing ratio of yield to FX risk. FX volatility is higher and the yield cushion is lower. The yield to worst has fallen 150 bps in six years. The yield covers 5% of one standard deviation in FX risk. The numbers are worse if you are buying ...

Everyone talks about the retune to risk trade-off, but it is a concept that is at times hard to visualize.  A simple tool is to form return to risk boxes with well-known benchmarks. The return to risk boxes represent the area of higher return and lower relative to some benchmark. If you are in the box, you have a better return to risk trade-off. If you are outside the box, your return to risk is inferior. You can look at a large number of managers or indices in one graph through the box approach.  In the graph above, we have included global macro and managed futures indices as well as the S&P 500 index (green circle) and Barclays Aggregate bond index (green square) for the last 12 months of return and 36 months of volatility. The triangles represent the major managed futures and global macro indices. We have not labeled them to make the graph a little cleaner. The other green circle is the MSCI world index.  The graph tells a very interesting story. All but one index ...