Some Benefits Of Trading Across Asset Classes-Or An Advertisement For Global Macro

With only a few weeks left in 2015 it would be a fair statement to say that there has been a lot of troubles in the asset management business. US Stocks are flat, bonds are flat, foreign stocks are down, commodities are down, junk bonds are down, and gold is down.  Here is a year to date performance chart of some of the major asset classes.  As you can see it has been less than ideal for the long only world.

Asset Classes

Some Major Asset Classes YTD

Years like this are why we are such big fans of being able to go long/short across asset classes.  In our model portfolio equities have been a drag in 2015 of a bit over -4.00%. We were short emerging market stocks for part of their fall but aside from that we mainly lost money on our equity trades.  Fixed income added slightly less than +1.00%. Being short commodities off and on, gold and copper, has added around +5%. This year currencies have been our big winner adding over +13.00%. As of last night our model portfolio is up 15.60%. Our worst drawdown on the year was -5.35% and we are currently down -1.83 from our equity highs.

TheMacroTrader.com Model Portfolio Equity Curve 2015

TheMacroTrader.com Model Portfolio Equity Curve 2015

If we had a fixed mandate of being only long equities, long fixed income. or long anything we would have been flat at best and probably negative for the year. Instead we had the flexibility to go where we found the best risk/reward opportunities.

 

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research

 

 

 

 

Global Macro-Generate Superior Returns With Less Risk

We at The Macro Trader are obviously fans of Global Macro as an investment strategy and even philosophy. Fortunately the data backs us up showing that global macro not only generates higher returns but does it with far lower risk than equities.

The chart below shows how you would have done if you had invested $1,000 into the Credit Suisse Macro Hedge Fund Index, SP500, and Barclays Aggregate Bond Index since 1994. As you can see the CS Macro Hedge Fund Index did drastically better than either stocks or bonds. To be more specific the CS Macro Index beat the SP500 by 2.11 times and the AGG Index by 2.75 times.  So that shows the returns but what about the risk taken to achieve these returns?

Global Macro vs SP500 vs Lehman AGG Bond Index

Global Macro vs SP500 vs Lehman AGG Bond Index

We have a few different charts to display the risks taken to generate the returns in each index. First we will show the historical drawdown charts. A drawdown is simply anytime you are not at new highs in your account. If you have $100 and lose $5 you are in a -5% drawdown. The deeper the drawdown the higher the return needed to get back to breakeven and the math, while simple, can be tricky. For instance if you lose -50% many think you need to make 50% to get to breakeven. The reality is that you need 100% to get to breakeven. In our case of being down -5% you only need a 5.26% return to get to breakeven but it gets harder the deeper you get.

Looking at a drawdown chart of the SP500 you can see that not only are stocks usually in a drawdown but over the past 20+ years we have had two massive drawdowns that took years to make up. We know them as the DotCom crash and the GFC-Global Financial Crisis. It took the SP500 57 months to recover from the DotCom crash and 50 months to recover from the GFC.

SP500-Drawdowns

SP500-Drawdowns

At the opposite end of the spectrum we have the drawdowns of the Barclays AGG Fixed Income Index. As you can see the AGG Index has frequent but small drawdowns with the worst one barely dropping below -5%. It only took nine months for the AGG index to fully recover from the worst drawdown and three months to recover from the second deepest drawdown.

Lehman/Barclays AGG Fixed Income Index Drawdowns

Lehman/Barclays AGG Fixed Income Index Drawdowns

Finally we have the CS Global Macro Index drawdowns. As you can see its worst drawdown was a -26.79% and its second worst was -14.94%. It took 19 months to recover from the -26% drawdown and 19 months to recover from the -14.94% drawdown.

Credit Suisse Global Macro Index Drawdowns

Credit Suisse Global Macro Index Drawdowns

Another way to show the depth and length of the drawdowns is to plot both the equity line as well as the new highs line. In each of the next three charts the green line equals the highest the equity line got, notice it never dips down, and the red line is the equity curve which goes both up and down.

Here is the SP500. As you can see while it hit a new high in 2007 it then went back down. In essence it took about 12 years before investors were really making new money. While this is a worse than “normal” period it is also not the first or the second time that the stock market has had a rough decade.

SP500 DD and NH

SP500 DD and NH

Looking at the AGG Fixed Income Index we see that the drawdowns are both shallow and short. If you were in the AGG Index you would not make the most money but you also took very little risk.

Lehman-Barclays AGG Fixed Income Index DD and NH

Lehman-Barclays AGG Fixed Income Index DD and NH

Finally we have the CS Global Macro Index. As you can see the drawdowns while larger than that of the AGG index are far smaller than the SP500 index. It kind of takes the middle route in regards to risk but it drastically outperforms both in regards to return.

Credit Suisse Global Macro Index DD and NH

Credit Suisse Global Macro Index DD and NH

Another way to look at the risk and return is to look at the 12-Month Rolling Returns. At any point in the chart you are looking at the returns you would have gotten if you had invested 12-Months ago.  As you can see the SP500-red line has the highest 12-Month returns but also the lowest 12-Month returns. The AGG Index-green line almost always shows positive returns but it never has a really big year. Finally the CS Macro Index-blue line again comes somewhere in the middle. It is positive almost as often as the bond index but the 12-Month period to 12-Month period returns are less than stocks.

Global Macro-SP500-AGG 12-Month Rolling Returns

Global Macro-SP500-AGG 12-Month Rolling Returns

Basically global macro has lower volatility and more consistent returns than the stock market and almost as consistent returns and far more gains than the bond market.  The main reason that this is possible is that as opposed to either the stock or bond index a global macro fund can go long and short anything and trade derivatives on anything. Most macro managers stick to liquid instruments but that still means you have hundreds if not thousands of tradeable instruments. The flexibility inherent in global macro allows you to always find a bull market somewhere whether that is being long stocks, short stocks, long the Australian Dollar, or short the Australian Dollar. You can bet on US Treasuries against German Bunds or across almost any other market relationship you can think of. Not only is global macro flexible but macro managers are famous for stringent risk management practices. It is almost cliche but in the end risk management is one of the keys to success in any trading approach and one of the most important things that separate macro from long only buy and hold.

What about claims in the press that “hedge funds have under-performed the SP500 since the GFC?” Well that is true but if you are picking only half a cycle than it is probably not a fair comparison. In the chart below you can see what happened to the CS Macro Index and the SP500 from the end of 2008 until the end of August 2015. As you can see the stock market is ahead.

2009-Now

2009-Now

Of course that was just in a bull move when everything was headed up. If instead of the end of 2008 or the end of February 2009 we use 2007 as our starting point we get a drastically different result. In this case the flexibility and risk reduction inherent in the global macro approach shines as the CS Macro Index outperforms the SP500 with both higher returns and far lower risk.

2007-Now

2007-Now

As far back as we have data global macro has outperformed both stocks and bonds across full market cycle. On the other hand long only equities has been profitable but has had some very long and deep periods of negative returns.  We are obviously biased towards global macro. We have a site and run a research service dedicated to it. You could say we drank the kool-aid and live and breathe this stuff. At the same time however many of the most successful money managers in history have been macro managers and the data shows that when done right it can lead to both higher absolute and risk adjusted returns.  So while we are indeed biased we think that the case is fairly strong in our favor.

 

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research

Does This Feel Like Mid-2007?

We track volatility across asset classes and throughout this year, especially the second half, have been amazed and the consistent volatility compression across assets. Here is our Average VIX where we take a simple average of several different volatility indices. Right now we are sitting at levels last seen in mid-2007 and we are struck with the complacency in the marketplace.(Click on chart to enlarge)

Are the potential risks really so small that no one finds it worthwhile to buy protection? A short list of potential risks would be the sovereign debt issues, fiscal cliff, Europe, Japan, China, Italy, Middle East, etc.,we can almost literally go on forever. Our current list of risks is as high as it has ever been and yet volatility is getting lower and lower from already low levels. While the Bernanke put has some power we question whether it is really the holy grail of safety nets. Just something to think about as we watch European stocks breaking out and US equities moving higher while at the same time Treasuries continue to catch a bid.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research

Peak Oil With a Dash of Politics

We were not planning on doing this post today but after a few conversation that I have had with people that consider themselves informed I thought that it would not hurt.

Oil is in the headlines again as both West Texas and Brent crude have been consistently over $100 for a while now. Of course this isn’t the whole story as we are also in an election year. The price at the pump matters more than normal around elections as voters like to blame or praise whoever is in power for any and everything that is going on.

This is a good time for a disclaimer-Some people might call me right of the right wing when it comes to personal views and voting. When it comes to trading politics absolutely need to be put aside. I take a pragmatic view of things and never confuse politics with policy.

Getting back to oil we keep hearing that when Obama came into office prices at the pump were so low. Well that is a half truth. As you can see in the chart below the price of Crude is in fact higher than when Obama took office.(Click on chart to enlarge)

What we never see however is what oil was doing before Obama took office. If we pull up a 10-Year of crude we can see that not only was oil at its cycle lows when Obama came in but it had just dropped from its all time high of $150 a barrel. Oh and do you remember why oil dropped like a rock? There is a thing called demand destruction. It tends to happen when the globe loses about a third of its wealth inside of a year. Since then we have had a recovery, even if it has not been as robust as we would like, the central banks of the world have pumped in trillions of dollars into the global economy, the Middle East has been in its “Arab Spring” for over a year, and we still have no long term energy policy.(Click on chart to enlarge)

No energy policy? Hah Obama must be doing this to us. If he had that much power then unemployment would be at zero. Fortunately the President while the most powerful man in the world is not that powerful. Until the office of the Presidency includes some grand wizard of alchemy he, no matter which party he is in, will have that power. Obama is responsible for higher prices only to the extent that he like his predecessors have failed to formulate any type of long term energy policy. Just like the developed worlds central banks and their debt can, we keep kicking the energy can down the road as well. T Boone Pickens is not lying when he says that every President since Nixon has declared that we will be energy independent and then has proceeded to do nothing.

So while there are definitely several shorter term issues driving oil such as the problems in Iran and current supply issues to both coasts, the biggest issue is that long term supply is not as strong as we once thought it to be. Most of the world has always thought that Saudi Arabia would always be able to boost production in times of crisis. Well as we saw when Libya had their revolution Saudi Arabia either does not have, or just doesn’t want to use, any spare supply. That fear coupled with more immediate issues is what is keeping oil above $100 and what will likely keep it above $80 for a long time if not forever. What’s that you say? Saudi Arabia can never run out of oil you say? In the chart below we present Middle East oil as a percentage of total global production. As you can see their share of production has not moved since the late-eighties.(Click on chart to enlarge)

What about the rest of the world? Brazil and Russia have a lot of oil don’t they? Well to certain extent they do but that does not mean they have enough to supply the world or to make up for missing supply in times of war or crisis. Here is a chart of global oil production along with the average annual price of crude oil. As you can see during the entire rise in price, production levels were not able to rise to keep prices in line, or to further enrich whatever country has this huge hidden supply of oil the world seems to be banking on.(Click on chart to enlarge)

Getting back to the United States can’t we just drill our way out of this mess? If we got rid of Obama we could drill everywhere and then we would have all the oil we would ever need. As much as some pundits would want you to believe that the truth is that our oil production peaked back in 1970. If in 40 years we have not been able to find enough oil to keep up with our demand then good luck finding all of this supposed oil today. Yes, there is untapped oil but do you really think that it will be enough? Peak oil people could be wrong and we could find Ghawar 2.0 in your backyard?(Click on chart to enlarge)

Oh but what about offshore production? Can’t we just go drill of the coast of California? They have already tried that and while they definitely did
find some oil and some is not currently being pumped there was nothing to lead oil experts to think that there were any mega-wells out there. While on the subject what was happening to offshore oil drilling before the BP spill? Yes, as you can see in the chart below even before the spill oil production was dropping like its hot for almost five years. Not only that but that is coming off levels not surpasses since 1995, an entire 15 years earlier.(Click on chart to enlarge)

So while Solyndra is obviously not the solution to anything, except how to lose taxpayer money, the President can not just wave a wand and have oil start seeping from the ground. Global peak oil is as real as United States peak oil. We are not working towards a long term solution which means that every time anything happens in the Middle East, Russia,
or even Brazil the price of oil will rise. Because of global energy uncertainty oil probably has a long term floor in the $80 area.

What can we do to change this? Well some items that would fit into an energy policy would be natural gas, rail, solar, etc. But until we admit that oil doesn’t grow on trees we will continue to revisit the spot where we now stand and it will happen more often and probably with more force each time. In our work and model portfolio we have a bias towards being long of energy as the long term risk reward is definitely slanted to the upside.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-In our model portfolio we are long OIL, XOP, and short some refiners.

Take a $1 trial of The Macro Trader to receive unbiased actionable research

And the Slowdown-Crash Continues

Right now we think it highly likely that going forward we see an increase in the rate of economic deterioration. Europe is already in a mess but the economy in the United States is now showing signs of its last gasp of growth. One indicator that we track is the Citi Economic Surprise Index. In the chart below you can see that economic numbers have been coming in very strong for the past few months. Based upon previous history it is safe to say that we have peaked or are very near peaking and that economic numbers going forward should start to turn lower.

Citi Economic Surprise Index USD and G-10

Not only are economic numbers expected to turn lower but we are also seeing several signs that inflation is dropping. One relationship that we follow closely is that of the CRB Raw Industrials Index against the SP500. As you can see in the chart below the two are usually very correlated. When the industrials are moving higher stocks usually follow and when they turn down stocks tend to do the same. Right now there is a disconnect, one that we expect to be resolved with the SP500 moving lower.

CRB Raw Industrials Index and SP500

This relationship matters because if inflation moves lower the stock market will as well. We can see this very clearly in the next chart where we have overlaid the weekly SP500 with the 10-Yr TIPS breakeven rate. As you can see these have a very tight relationship. What you can’t see is that this relationship goes back long before the crisis. When inflation expectations rise the stock market rises and when they fall the market falls.

SP500 and 10-Yr Breakeven Rate

Other signs that inflation is not upon are that government bond yields are hovering around historic lows. As you can see in the next chart the 2-Year Treasury yield has been low and headed lower. Despite all the hype regarding hyperinflation we have not seen any of it, and based upon the messages from the bond market we are not seeing it anytime soon. In case you are wondering we are seeing the same thing farther out on the curve with 10 and 30 year yields also near their lows.

2-Yr US Treasury Yield

Another sign that we have been following is this chart of the Shanghai composite and the CRB index. As you can see the two indexes peaked within two weeks of each other and have been steadily working their way lower for the past eight months. As the nation of commodity stockpiling has slowed down so have their stockpiles. As this huge underlying commodity bid has vanished it has allowed industrial commodities to drop.

Shanghai Composite and CRB Index

Whether it becomes an all out crash, ala 2008, or not is not known but we are confident that the global slowdown will continue. So what have we done with this view? In our model portfolio we are short the AUD/USD as we expect the Australian Dollar to move lower as commodity prices and Asian demand continues to falter. We are short the EUR/USD via options in a trade we placed back in August. Recently we bought the USD/CHF as we expect the Swiss Franc to weaken considerably from here. We are also short the SP500 via options and long the Lehman/Barclays Aggregate index which is highly weighted with US Treasuries and investment grade credits.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research