Global macro trading perspective courtesy of Rareview Macro Nov 3 edition of Sight Beyond Sight. MarketsMuse Editor Note: Rareview Macro’s model portfolio has gained 16.5% YTD, during which time the majority of macro-style funds have returned less than 5% on average, illustrating why this newsletter is more than just a newsletter.
We start with the global benchmark for beta and risk – the S&P 500. The debate amongst professionals is focused on two big issues:
- An expectation that seasonality will override any negative factors.
- There is historical precedent for consolidation and/or weakness. If weakness were to become the overriding theme, then it could be longer and deeper than expected because a series of market studies that looked at the speed and degree of the recent gains show a poor risk/reward profile in the near term.
So which is it?
After speaking with 10 investors in our circle, all of whom we respect, the current score is that 7 would side with seasonality being the overriding factor and 3 are calling for a 5% pullback in the S&P 500 and expect the market to remain range bound for the remainder of the year.
Personally, we struggle with this debate and the 7-3 scorecard. We pride ourselves on not being dogmatic in our views, especially around bulls, bears, inflation, deflation or simplifying our model portfolio into two polar viewpoints. This is particularly true given this stock market is well-known for behaving in unprecedented ways.
What we would say instead is this:
For all the emphasis placed on fundamental bottoms-up research right now, the more important exercise is simply getting the timing, direction and size right of a portfolio strategy.
In that spirit, we have learned to place more importance on identifying the trends to start November rather than those to begin the new calendar year, which will generate considerably more debate and throw up new investing themes. The only parallel point is that, as in January, the month before is quickly forgotten. So in this case the speed and degree of the rebound from the October lows is now no longer part of the narrative.
The reason we place more emphasis on November is that there is tangible information that provides an edge whereas January is more arbitrary and may be mainly about following the crowd.
Let us explain.
Our main thesis is that professionals are highly sensitive to “pattern recognition”.
Firstly, it has been well noted that buying the S&P 500 close on October 27th is the single most bullish day to hold for 5 days since 1950. Thus far 4 out of those 5 days are up 2.84%. Today, the fifth day in the sequence is unknown.
Secondly, but less widely discussed, is that October 31st is a critical date as it marks the fiscal year-end for most mutual funds. So those stocks that are held at that time are what will appear in the annual report for every fund. For those who subscribe to “window-dressing” theories, this fits nicely into the best 5-day period statistics.
Thirdly, monthly seasonal patterns have had an impact on stock returns. For example, it is well understood that today is the start of the best six month period of a year. However, what is less understood are the following three statistics:
- From Q4-Q2 during midterm elections (i.e. tomorrow), the market is up 100% of the time (16 occurrences);
- The average increase from the end of October to May for the past 30 years is 8.5%.
- 11 of 11 years ending in 5 (i.e. 2015 next) are up, an average of 32% (i.e. less risk in Jan if Nov/Dec are strong).
While just a few tangible examples, this is the kind of “pattern recognition” that professionals are the most sensitive to and by extension reduce their risk exposure over the concern of a period of consolidation and/or weakness that follows the strong October bounce back.
Now there are ~40 trading days left in 2014 and everyone is searching for an idea on how to best leverage the little amount of time that remains, keeping in mind the seasonality. The gap between the major long/short hedge fund indices and the benchmarks that they track are very wide (i.e. 7-9% underperformance). The same could be said, albeit to a lesser degree, for macro strategies that use the same custom benchmark as us – 40% MSCI World Index, 30% Barclays Aggregate Index, 20% US Dollar Index, and 10% DJ UBS Commodities Index. This is not the case for risk parity or long only equity strategies.
The search for value in pro-growth risk assets following the October 15th climactic low has largely played out. Put another way, the low hanging fruit has already been picked. Inquiries about new idea generation were thematic last week. This exercise far outweighed examples of investors taking profits or adding hedges into record highs in our opinion.
There are two main ways out of the predicament professionals find themselves in.
Firstly, find the beta instrument that has lagged and buy that on the view it will accelerate faster than the S&P 500 going into the end of the year (i.e. Euro Stoxx, European Financials, MSCI Emerging Markets, S&P MidCap 400 Index, worst of the worst single names, etc.).
Secondly, buy the stocks that are making new yearly or all-time highs and the ones that have the greatest YTD outperformance (on Bloomberg see SPX Index MRR for ranked returns). Put another way, embrace the situations that are breaking out and ride their momentum.
To read the remainder of this edition of Sight Beyond Sight, free trial subscription (no credit card info is required) can be secured directly from Rareview Macro website by clicking on this link.