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

Optimists Survive By Eating Bears

Today (9/10/15) David Tepper came on CNBC for an hour. The whole discussion is worth watching but one thing he said is missed time and time again by many investors.

“I’m not real comfortable being short stocks because there’s a bias for stocks to go up over time”-Tepper

Tepper has been putting up 25-30% returns for over 20-Years with billions under management. He is one of the best traders in history, great at sizing up risk reward, security selection, and timing….and yet he says “I’m not real comfortable being short stocks because there’s a bias for stocks to go up over time.”

One of the sub-segments of the investment/econ space that I enjoy are the “end of the world as we know it” genre. They are mainly published at market bottoms while the super bullish books are published at market tops (remember Dow 40,000?) but we also see a lot of them mid cycle as well. For whatever reason doom and gloom sells very well. The short argument always sounds like the intelligent argument. To make it worse there is always a lot of data that shows real reasons to be worried. Look at any of the books in the picture below and they are filled with data and charts showing impending doom. If you look at the publishing dates however they either missed the crash or just got the entire thesis wrong. (BTW I recently moved and have not unfinished packing or I could have shown a stack four feet high of end of the world books. For whatever reason I cannot resist the urge when I am in a used bookstore).

The end of the world

The end of the world

What the perma-bears get wrong is that over time civilization has indeed improved its lot in life. Yes, there are downturns but more often than not stocks go UP and not down. If someone as smart as Tepper is wary of shorting then what does that say about what you should be doing?

Looking at US assets over time using data from the Credit Suisse Global Investment Returns Yearbook we can see that stocks go up….a lot….over time. Even after taking into account inflation you would have 1,396 times your money from 1900-2014. Bonds and bills are less explosive but even there they go up over time.

Cumulative Real Returns USA

Cumulative Real Returns USA

Over the past 115 years you would have been fighting a 6.5% annual upwards drift by shorting stocks. That means that you are fighting a 0.54% hurdle each month. And of course that doesn’t even include any borrowing costs, commissions, or taxes.

Annualized Real Returns USA

Annualized Real Returns USA

Now all of this is not to say that we don’t short because we do. We have had success going long and short across asset classes to include stocks. What I am saying is that you need to have a really good reason to fight long term trends in markets. If you can’t figure out why you have an edge on any given trade then you are probably better off not doing it. Oh and in case you are wondering “stocks are overvalued” or “Because the Fed” are not sufficient answers.

If you want more info on the long term bias of stocks to go higher, or just want to get a lot smarter, pick up a copy of the book “Triumph of the Optimists” by Dimson, Marsh, and Staunton.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

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

 

You Are Using HYG and JNK All Wrong, Here Is What To Do About It

Historically junk bonds, also known as high yield bonds, correlate quite well with equities. In fact we have built timing systems that use junk bonds as a trend confirmation indicator that have done quite well from a historical perspective.  Because of all this we, as well as half the internet, love that the junk bond ETF’s HYG and JNK exist. They are both great trading vehicles and a fantastic aid in our intermarket analysis and to measure investor risk sentiment in both the equity and bond markets.  All that said there are two major ways in in which we see them misused all the time.

First lets look at charts of the SP500 and HYG. As you can see in the chart below the SP500 as represented by SPY has been trending higher despite the almost 10% pullback in October. In fact it is at new all time highs right now.

SPY-SP500 ETF Total Return

Next we have a chart of HYG. As you can see it has been diverging from the SP500 since the end of June and has been sloppily trending lower ever since.

HYG-IBOXX Junk Bond ETF Total Return

Many analysts and traders have been posting these charts and saying that since there is a growing divergence between junk bonds and equities that we have to see a move lower in equities to bring things back into line. There are potentially a lot of things wrong with this statement but the one we want to look at right now is the idea that they are diverging. If virtually ALL the stocks in the SP500 were moving up and virtually ALL the bonds in HYG were moving down then we would indeed be worried about a major divergence. Rarely does investor sentiment go all in on equities and all out on junk bonds or vice versa.

So what is the problem? We don’t see a real divergence.  The secret is that not all of the stocks or all of the bonds are diverging.  If we look at an industry group breakdown we see something very important, namely that almost 15% of it is made up of oil and gas companies.  Do you think it might be important to know that the highest industry weighting is made up of a sector of the market that has been gored by the bears in the woods?

HYG Industry Group Breakdown

In fact if we look at a performance chart of the above groups we can see that there is not a real divergence. Over the past six months stocks have gone higher, junk bonds are basically flat, and oil and gas stocks have been absolutely hammered. Consequently in our view this is NOT a bearish divergence as most junk bonds are not dropping in the face of a rising stock market but instead only the oil and gas junk bonds are dropping.

SPY HYG JNK Oil Gas Performance Chart

While the above can be said to be up for debate we think the case is fairly solid that this so called divergence is less indicative than most seem to think. The next issue with how people use HYG and JNK is far less debatable.  Have you seen any of these charts showing the ratio between HYG and TLT? Most people use it to gauge investor sentiment. Are investors running to safety in Treasuries or are they going to the opposite end of the fixed income risk spectrum and buying junk bonds?  We think the concept is completely valid but the implementation is less so.

Here is a chart of the ratio of HYG and TLT. As you can see it has been trending downward for all of 2014 as long term Treasuries have vastly outperformed their junk bond cousins.  The problem is that usually you want to compare first or second cousins and not tenth cousins.

HYG and TLT Ratio

If you just went WTF is this guy talking about we don’t blame you, so let me explain.  In the bond world there is a thing called maturity which is simply how long until the bond is paid back.  TLT is a 20+ year bond ETF which means that it is full of bonds that end in 20+ years. In fact 90% of TLT is comprised of 25+ year Treasuries.  Where the HYG/TLT ratio breaks down is when we then look at the HYG or JNK maturity profiles.  As you can see in the table below 95% of HYG is comprised of 1-10 year bonds with less than 3% being more than 10 years.

HYG Maturity Profile

HYG Maturity Profile

The story is much the same with JNK as almost 94% of the bonds in JNK have a maturity of 3-10 years. And just like HYG, less than 3% is made up of bonds with maturities over 10 years.

JNK Maturity Profile

JNK Maturity Profile

So while the idea of a junk bond/Treasury bond ratio is great, using TLT as the Treasury component is less than ideal as the maturity mismatch is so large.  Lucky for us there are several other Treasury ETF’s and they are made up with ranges of maturity. TLT is 20+ years but did you know that IEF is a 7-10 year ETF and IEI is a 3-7 year ETF.  Either of these would be a far better choice for this indicator than TLT as we are able to compare first or second cousins instead of tenth cousins.

So what are these more accurately matched up ratios saying now? HYG/IEF shows that fixed income investors were happy to own junk bonds for the first half of the year and since then junk bonds have drastically under-performed.   Of course since the oil and gas sectors took their dive at the same time it is up to you to decide if the under-performance of junk bonds is as bearish as it usually it. We are discounting it but are still wary.

HYG and IEF Ratio

Looking at the HYG/IEI ratio things are even less bearish as the downtrend has been both shorter and less damaging.  Like above we think that the under-performance in junk bonds has largely been in the oil patch with other sectors barely affected. Consequently we are wary and yet modestly bullish on risk.

HYG and IEI Ratio

ETF’s, indices, securities, and other indicators are all well and good but it is important to look under the hood as much as possible so that you are drawing the right conclusions.  In this case you can decide if you should discount the under-performance of oil and gas and the subsequent divergence between junk bonds and stocks but we think that anyone that looks at the Junk/Treasury ratio needs to be using a proper maturity comparison or they are doing it wrong.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

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

The Great Rotation? More Like The Great Lie

So far this year I think my most hated new term is “The Great Rotation”.  Supposedly stocks are moving higher as money is flowing from the overpriced bond market and into equities.  Since the term has gone ballistic, also known as annoying, we decided to look into it.

Here is a chart from Google Trends showing how search volume has gone crazy. Until the past few months it barely existed although it was moving higher into year end but more on that in a minute. (Click on chart to enlarge)

Gtrends-Great Rotation

 

 

Looking at the performance of stocks versus bonds we can see part of the reason why the term was becoming popular.  Without reading too much into it stocks were moving higher while bonds were moving lower…..most of the time. (Click on chart to enlarge)

Stocks-vs-Bonds

While stocks have indeed been outperforming bonds over the past few months the other side of the case for “the great rotation” was that money was coming out of bonds and going into stocks.  Well thanks to the ICI we have data that allows us to look at this idea.  Stocks funds saw a large increase in assets of 5.2% from December to January but Bonds also saw in increase in assets. (Click on table to enlarge)

Net asset table-ICI

We are not sure exactly where the rotation is here so we then broke down the weekly data to see if we could discern this rotation pattern in the data.  Well what we found was that year end and beginning of the year investment trends have a strong seasonal pattern.  Want to guess what the pattern is?  If you said mixed into year end and positive at the beginning of the new year then you win.  Here is the weekly data for equities from the beginning of 2007 to now.  We decided to show data from the beginning of October through the end of February in order to give the rotation argument as much rope as it might need. While 2013 has definitely seen the largest January flows  since 2007, the reality is that every single January sees positive flows.  (Click on chart to enlarge)

ICI-Equity Total Net New Cash-Weekly

What about bonds?  Well we already spoiled that surprise earlier with the ICI table so you know that bonds saw inflows but guess what we found?  If you said seasonality you win…again.  Not surprisingly the past seven years have seen net inflows to bonds the majority of the time but the flows are a lot smoother at the beginning of the year as investors obviously put a lot of money to work each and every January. (Click on chart to enlarge)

Total Bond Net New Cash-ICI

Here is a chart of the cumulative in and outflows for both equity and fixed income funds.  As you can see bond funds have been the asset gathering champions of the past 6+ years as they have seen huge net inflows almost the entire time. At the same time equity funds have been net asset losers.  What of course sticks out to us is that over the past little while equities have indeed made some inroads but that there is zero rotation going on. Let me repeat that-there is zero rotation going on.  (Click on chart to enlarge)

ICI-Cumulative Flows

We know that we have not accounted for ETF’s, Closed End Funds, Hedge Funds, etc.  but from the data we have seen, with one exception, we are seeing the same thing.  Namely that equities are getting more more money but that fixed income is still getting net new money.  What is the one exception?  We have come to the conclusion that the vast majority of the new money has come from two places: money market funds and all the special one time dividends that got paid out at the end of last year in anticipation of higher dividend taxes this year.

If you want to call a slight drop in assets in money market funds a great rotation go ahead but just know that you are full of it.  Which gets us to our last point, this is all marketing.  I don’t know where this meme originated but we would put money on it being from an equity shop that was sick of losing assets both in absolute as well as relative terms while the fixed income guys were killing it over the past six years.  We have not seen a slew of advertisements for the rotation yet but here is a classic ad that you can refer to anytime your broker, advisor, etc. calls you up with a pitch so that you maintain a healthy degree of skepticism. (Click on ad to enlarge) 

Fido

Stocks can go up or down while bonds go up or down and there can be great reasons to buy or sell either but “The Great Rotation” is not one of them.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

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