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

 

 

 

 

Macro Is Dead, Long Live Macro

If you read the popular financial press you may be led to believe that because a few macro funds have closed down this year, a few legendary traders have closed their funds over the past few years, and because global macro as a category has done poorly post-crisis that macro is dead.  If we have learned anything post-DotCOM bubble it is that when a strategy has died it is really just coming back to life.

Let’s address the above reasons for macro’s supposed death. The first is that a few prominent funds have closed this year. Everest, COMAC, and Fortress have or are closing their doors. They all got hit hard when the Swiss National Bank blew their EUR/CHF peg earlier this year. Everest basically blew up, COMAC decided to turn into a family office, and Fortress kept fighting the fight in public until announcing a few weeks ago that it is closing up its macro business. Here is the thing though, of the three only one lost “all” their money. COMAC was down something like -8% and decided to turn into a family office while Fortress appears to have been down around -17% before shutting its doors.  Have you EVER heard of a long only equity guy closing up shop after a -8 or -17% drawdown? Have you ever heard anyone say that “the SP500 should be shut down because in the 2000’s it has been down over -50% not once but TWICE? It is kind of ridiculous to extrapolate that an entire category of trading is dead because a few guys were down a bit and decided that instead of dealing with the press they would rather just deal with their personal account.

This segways nicely into our next point regarding “a few legendary traders have closed their funds over the past few years.” To think that macro is dead because Soros and Druckenmiller both returned outside money is ridiculous. Forbes has Soros net worth at like $25 billion and Druckenmiller at $4.5 billion. Now I have no idea if their true net worth is half the Forbes number or double the Forbes number but either way they both have billions, have both been working for a long time, and both can still trade, or not trade, while enjoying whatever they feel like enjoying.  And for those that want to say “but Druck was down -5% when he shut down his fund” my response is you’re an idiot. He returned 30%+ forever, all his investors had net gains, and for all you know by the time the year was closed out he was up double digits. Again being down -5% is not really a big deal. In fact the SP500 was down double digits just a few weeks ago…..and I didn’t hear anyone saying “this is proof that market capitalization weighted indexes have lost their touch.” Oh and in case you are wondering by all accounts Druckenmiller made a bunch of money in 2014 and so far in 2015 so I am pretty sure his “loss of touch” was more his “I am sick of shuffling papers I just want to hang out with my family, trade my own money, and watch the Steeler’s play football.

Investing is different from most other professions in that if you are at the top of your game going private gives you a better chance of outperforming than if you are in the public eye. If you are an athlete, musician, artist, doctor, engineer, etc. you need to see people and do things with people in order to know if you are any good or not. Trading is different in that at the end of the day you can see your returns and you don’t have to care if anyone else does.

The last point, at least for today, is concerning the idea that because global macro has done less than awesome post-crisis it is useless and must be dead. Remember 1998, 99, and 2000? Julian Robertson closed his shop, Warren Buffett was down -51%, and value investing was dead. Yeah I wonder how that turned out. Remember around that same time how commodities had done nothing for what some might refer to as “forever”? Over the next 10 years both value and commodities did awesome. By the way what do both Julian and Warren B have in common? They are both called “value” investors but they have also both traded commodities, derivatives, currencies, and anything else that represented “value” to them. At the same time we have someone like Joel Greenblatt who has always been a stock/bond value guy and a Bill Miller who runs equity only mutual funds.  All of these guys would be lumped into the same value bucket and yet they all invest wildly different and have very different business structures.

Some funds, macro and otherwise, have investors who want very low volatility and decent returns. If you are a pension fund that “needs” 7% a year over time then a 20% year is great but a -10% year is the end of the world. The pension funds goals are steady and consistent returns but they have no need for shoot the lights out performance. Other investors on the other hand give a manager a portion of their money and they expect high returns and understand that usually that entails the potential for more risk. There are many other classes of investors but these two will do in order to make this point. Most hedge funds these days, macro or otherwise, are not playing to the sound of the SP500. They are not in the business of playing to some benchmark that someone from the media picked for them. Instead they are trying to play to the benchmark that they have set with their investors. Some of the investors have no economic incentive to beat the SP500 but instead to match their liabilities…..and this is why, or at least a huge part of why, “hedge funds have under-performed” post-crisis.

With all the different strategies and business models inside of strategy categories it is stupid to lump them all together. One of these days I will write a larger post on why the media gets hedge funds wrong but this is one of the key reasons.

All this is a long way of saying, and I am not sure how well I said it, that global macro is not dead and can’t really die. As long as their are trends, and there always are, there will always be some people on the right side and others on the wrong side of them.

By the way we have seen reports of a lot of managers being up double digits even while other funds are struggling. In the case of our newsletter, and of course I have to tout it, we are up around 14% for the year. We are directional macro looking to take 5-15 positions long and short across stocks, bonds, commodities, and currencies at any one time. If this type of thing sounds interesting to you then please take a trial of our service.

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

How To Lose All Your Money….Or At Least More Than You Should

Today was the most watched Fed Day in years…and that’s saying a lot since every Fed Day seems to be the most important ever. US rates tanked across the board while other markets mostly flew higher only to close lower.

In our model portfolio we gained a whopping 8 basis points. That is 0.08% for the day. It obviously would have been nice to have gotten everything right and make more but the flip side is that we REALLY don’t want to get everything wrong and lose a lot.

One of our goals over the years has been to get the portfolio to where no one event, at least not a normally scheduled event, poses much risk to us. If a nuke lands in a major city we could take a big hit. If an alien lands in DC who knows what would happen. But if the Fed has a scheduled meeting we should not be overly exposed to anything that has much of a chance of happening.

One way we are able to do this is by diversifying across asset classes. In fact one of the best things about macro trading is that you are kind of supposed to go across asset classed looking for great risk/reward situations. Being long and short across assets is one way to minimize event risk. Another way is to have trades on with different primary drivers such as growth, inflation, relative value, events, etc. Basically bet on a diverse set of risks across a diverse set of assets.

Why stop there however when you can then focus on price correlations, structuring your trades, sizing your trades, and the placing of stops?

All of this to say that if you want to eventually lose all of your money then make sure that you don’t do any of the above. Make sure that your entire portfolio is based on being completely right on one thing. To make it even more fun ensure that the one thing has a small chance of happening. Why bet it all on a Fed outcome when you can go all in, even levered, on a bet that the USD will collapse and our entire system will go back to the stone ages.

While some of that was said in jest….at least kind of, the reality is that many long term portfolios are setup to only do well in one economic condition and even more “trader” portfolios are betting on one or two outcomes on different events.  If you want to improve your risk adjusted, as well as your absolute, returns then pay attention to this stuff, think about it, study it, etc. and see what you can do to improve your risk and diversification processes.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

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

 

 

Some Thoughts On Market Timing Part-1

This is the first in a series on what timing is, what it isn’t, and some right ways to do it. 

In recent days I have been experimenting with one of our proprietary indicators to expand its use. I named this indicator a “Risk Index” with the idea being when the indicator is high the risk are low and when the indicator is low the risks are high. As you can see in the chart below a higher percentage reading indicates a more favorable market and a lower reading indicates a less favorable market.

US Equity Risk Index

US Equity Risk Index

Our risk index is simply the percentage of out timing models that are bullish or bearish each week. For US equities we run 10 different models that look at trend, valuation, interest rates, inflation, sentiment, breadth, and intermarket relationships. I estimate that 53% of the individual components in the 10 models are equity trend based. There are a few reasons for this but the most important gets at the heart of timing. We use timing tools to help us first lower risk and in a distant second to increase returns. It turns out that trend following indicators while not a “Holy Grail” do a great job at keeping you in the big moves and minimizing your downside.

Our models come from many places. If you are familiar with Nelson Freeburg, Marty Zweig, and Ned Davis you would recognize a few of the models and would be able to see the inspiration in the other models.* Five of the 10 are straight from their material and the other five while homegrown take inspiration from their work. All the models have been backtested and while most of them slightly improve returns they all drastically improve drawdowns which is our primary goal.

So if each of these models is solid in its own right why would we take a consensus approach? There are several reasons but the two that stand out are that you never know when the market is going to change and invalidate a model. Now we can stand a prolonged period of under-performance but we cant handle a catastrophe.  If a model underperforms for a long enough period of time we would take it out if we could see that something had changed. As an example I once created a breadth based system that I was able to backtest and it generated low 20% returns with the worst drawdown being just over -7%. Well I got to use it for about a year before decimalization came and within weeks the results when to hell. I suspected something was off but it took a few more months to confirm it. I still update it and monitor it as it displays a certain segment of market behavior but its risk/reward is no longer favorable.

Of course most of the models in the risk index are based on weekly data and are longer term in nature. Still the risk is very real that something changes and some of them cease to be useful. By taking a consensus approach any downturn based on a degrading model can be minimized.

We are not going to get into the specifics of each model but instead how almost any model, in this case a consensus model, can be used. Don’t worry because in a future post we will go over how to build a simple but effective long term timing model.

So we have a US Equity model that is based on the buy/sell signals of 10 separate timing models. How can we use it? We could backtest it and see what readings give the best risk/reward and trade it that way but what inspired this post was the idea that we would just invest X% of a portfolio depending on the reading. If the model said that 50% of the models were on buy signals we would invest 50% of the portfolio and change it each time the buy signals percentage changed.  If that went well, it did, and sufficiently cut risk, it did, we could then experiment with different levels of leverage.

We did this with the data we had on hand and got the following results. Trading SPY-SP500 ETF, and using the total return series so that includes dividends, we got the following results. Buy and hold did fine on the upside but had a -50.77% drawdown. Timing trailed a bit on the upside but only suffered a -13.67% max drawdown. Finally by using a full 2X leverage we were able to cut buy and hold risk in half and increase returns by 1.89 times. In case you are wondering by using only 1.2X leverage you beat buy and hold by a few bucks but your max drawdown is still under -15%.

Risk Index SPY Returns and Drawdowns

Risk Index SPY Returns and Drawdowns

Looking at a chart of the equity curves for each of the strategies you can see how timing plus leverage killed buy and hold. Of course while max drawdown was far less the intermittent drawdowns were sometimes larger. Take 2011 for example when the market corrected just enough to turn the model down to 10% bullish only to rocket higher. That is the main risk to any system as you can get whipsawed in and out during a longer term trend. Of course anytime you are using leverage you can expect to have higher volatility at times as you are seeking higher returns.

Risk Index Equity Curves

Risk Index Equity Curves

Looking at the individual drawdown charts shows just how risky buy and hold is as the SPy-SP500 ETF was down over -50%. This of course requires a 100% return just to get back to breakeven.

Buy and Hold Drawdowns

Buy and Hold Drawdowns

Looking at the drawdowns for the timing without leverage equity curve you can see that while it has a lot of little drawdowns it has only had three double digit drawdowns since early 2008 with the worst one being -13.67%. It may have lagged in total return but not by much and as such would have been a lot easier to handle. Of course as we discussed one would only need 1.2X leverage to achieve equal returns with buy and hold with less than 1/3 the risk.

Timing Drawdowns

Timing Drawdowns

Finally we have the drawdown chart of the timing strategy but using 2X leverage. As you can see the worst drawdown was half of that of buy and hold. Of course the next two worst drawdowns also hit -20% in contrast to buy and hold which only had one more -20% drawdown. Still the overall risk has been cut in half and the returns almost doubled.

Timing Plus Leverage Drawdowns

Timing Plus Leverage Drawdowns

 

Why do we only have the risk index back to 4/11/08? We are working on extending it back a few decades but as we were building these we had some data limitations on two of our homegrown models. When we finish building them out we will share the results with our subscribers as well as the blog.  For now however we think that capturing most of the carnage of 2008 along with the correction of 2011 does a decent job of what can be accomplished with a good timing model and a few different ways to use it.

One aspect of this model that we like is that is gives a specific allocation percentage instead of just a buy/sell signal. This will be the purpose of a future post but if you go back and read all the Marty Zweig stuff, and Zweig was a timer if there ever was one, he never said to go all in or all out.

“How should you, the reader of this book, react to the constantly changing circumstances? Basically, I think you should shun the idea of buy-and-hold. I consider it a fallacious strategy. In the coming decade we are likely to see more bear markets and deeper ones. To lower risk, there will be periods when you should peel back your investments, in the stock and bond markets. It’s a matter of degree. You don’t have to go 100% to cash but you should cut back as risk rises and invest as risk recedes. I believe my market-timing methods in this book will help you do just that.”Marty Zweig from “Winning On Wall Street”

If you go read Howard Marks book “The Most Important Thing” you will find variations of the same concept. If you are a traditional value guy/gal your heart just skipped a beat as I said Howard Marks in the same post as “market timing”. The reality is that all active management has the same goal-minimize risk and maximize reward. Marks in his excellent book talks about assessing the range of future outcomes and  discusses risk throughout both his book and other writings. Despite different approaches both Marks and Zweig have the same goal. be aggressive when their indicators-be they book values or how much the ZUPI moved-say to be aggressive and back off when things look risky.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

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

 

*I can’t write this and not give credit where credit is due. Nelson Freeburg the late publisher of Formula Research was a fantastic guy and his publication as well as correspondence has had a great influence on me. In fact while the idea of combining timing models together was not new, the way in which he did it elevated my thinking to a new level in his January 15, 1998 issue “The Power of a Composite Stock Market Model”. The components of my risk index are very different but if you read that report you can not help but see similarities.  Aside from that report however he put out more interesting and functional models than anyone I know of. If you can get a hold of any, or all, of them you will be better for it.