The Capital Spectator

Recapping The Trump Years Through A Markets Lens

Wed, 20 Jan 2021 12:11:00 GMT

The 45th president’s term ends today, putting a fork in one of the most turbulent periods in American history to rest. As the nation prepares for the the Biden era, whatever that means, let’s take a quick look at how markets fared through Donald’s tenure, based on a set of exchange traded funds.

Let’s begin with a big-picture review of global equity markets via US, foreign developed and emerging markets slices from the close of Election Day in 2016 (Nov. 8) through yesterday (Jan. 19, 2021). The main takeaway on this front: US stocks (VTI) dramatically outperformed its counterparts (and the other major asset classes too). Vanguard Total US Stock Market (VTI) nearly doubled during this period with a 97% total return (all results throughout are cited as cumulative changes). Foreign shares, by contrast, rose roughly 50% to 60%, according to results for Vanguard FTSE Developed Markets (VEA) and Vanguard FTSE Emerging Markets (VWO).

Broad measures of US bonds ended the Trump era with gains, albeit modest compared with stocks. The iShares iBoxx $ US Investment Grade Corporate Bond ETF (LQD) topped this category with 29% advance. US junk bonds (JNK) were a close runner-up with a 26% gain. Inflation-indexed Treasuries (TIP) and US corporates (IEF) fell into the bottom half for returns with 19% and 16% gains, respectively.

Three major categories of foreign bonds (in unhedged terms) also delivered across-the-board gains in line with US fixed-income results. Topping the ex-US fixed-income category: VanEck Vectors International High Yield Bond (IHY), which rose 30%. By contrast, foreign developed government bonds (BWX) were up a bit more than 15% while government bonds issued by governments in emerging markets added 12%.

US and foreign real estate shares were essentially tied for Trump-era returns. Vanguard US Real Estate (VNQ) was up nearly 27%, slightly ahead of the 25% increase for Vanguard Global ex-U.S. Real Estate (VNQI).

Looking at four major categories for commodities reveals a mixed picture for the Trump era, based on four fund proxies run by Invesco. Precious metals (DBP) and base metals (DBB) had profitable run, rising 33% and 22%, respectively. A broad measure of energy (DBE) was flat during the Trump years while agriculture (DBA) shed 17%.

Finally, the US dollar endured a volatile ride since Trump became president but by the end of yesterday’s close the Invesco DB US Dollar Index Bullish Fund (UUP), which tracks the greenback relative to a basket of six major foreign currencies, was essentially unchanged. For comparison, an ETF proxy for a US dollar cash holding was up nearly 6%, based on iShares Short Treasury Bond (SHV).

And so ends the mostly bullish run for markets during the Trump years. As of 12:01 pm eastern today, the window is formally accepting your bets for the Biden era.

Learn To Use R For Portfolio Analysis
Quantitative Investment Portfolio Analytics In R:
An Introduction To R For Modeling Portfolio Risk and Return
By James Picerno

Macro Briefing: 20 January 2021

Wed, 20 Jan 2021 10:48:45 GMT

* Washington under tight security for today’s Biden inauguration ceremony
* Biden plans blizzard of executive orders to reverse Trump policies
* Yellen, next Treasury Secretary, promotes sweeping stimulus package
* Treasury nominee Yellen: US can afford higher corporate tax rate
* UK annual inflation picks up to 0.6% in Dec but still well below BoE’s 2% target
* Eurozone annual inflation remained negative in December at -0.3%
* Eurozone is capping bond yields–with a European twist
* US Treasury market’s 5-year implied inflation forecast rises to 3yr high: 2.12%:

The Small-Cap Equity Factor Is Humming Again. Will It Last?

Tue, 19 Jan 2021 12:28:06 GMT

Small-cap stocks have taken a back seat to large caps in recent years, but the relative drought is over. Or at least it’s faded in recent months, based on a set of exchange traded funds that represent a variety of US equity risk factors.

The shift in leadership is certainly conspicuous in the new year. Notably, three flavors of small-cap stocks (value, core and growth) are leading the field by a wide margin, based on 2021 returns through last week’s close (Jan. 15).

A few weeks could be noise, of course, but small caps also have an edge via ETF-based factor results since last year’s Mar. 23 market bottom, based on the broad market’s trough during the coronavirus crash. Since that point, small-cap growth, core and value have three of hte top-four spots for equity factor performance.

For a longer-run view, the next chart tracks the relative performance of small caps (IWB) vs. large caps (IWM) over the past 20 years. When the line is rising (falling), small caps are outperforming (underperforming) The recent revival in the fortunes of small caps is striking for the depth and rapidity of the shift.

What’s driving the small-cap rally? A popular narrative is that smaller companies are poised to be the leading beneficiaries of a post-pandemic economic rebound.

The question, of course, is whether the recent small-cap edge is noise or the start of an extended bull run that favors shares in the lesser capitalization realm? No one knows, but for the moment the crowd is giving small-cap stocks a fresh look.

Learn To Use R For Portfolio Analysis
Quantitative Investment Portfolio Analytics In R:
An Introduction To R For Modeling Portfolio Risk and Return
By James Picerno

To the extent that the bounce in small caps is drawing strength from macro optimism for the year ahead (and beyond), the US economy needs to pull out of its recent slowdown and deliver firmer growth. That’s a tall order at the moment, thanks to the latest post-holiday surge in coronavirus cases, deaths and hospitalizations. But with vaccines rolling out, the potential for relief is looking more plausible by the day.

There are hints that the deadly surge in the daily change in new US Covid-19 deaths has peaked. Coronavirus fatalities fell for a sixth day through yesterday (Jan. 18) after reaching a record high last week. It’s premature to declare victory, but for now the numbers are moving in the right direction.

Meanwhile, the incoming Biden administration is reportedly set to focus on a new round of coronavirus relief. Janet Yellen, President-elect Biden’s pick for Treasury Secretary, is expected to tell the Senate Finance Committee today that the federal government must “act big” with more stimulus.

Embedded in the small-cap rally is the assumption that meaningful progress is near for reversing the surge in unemployed workers. The weekly sky-high jobless claims data is a critical metric to watch for deciding if there’s a basis for the optimism.

Measured by the small-cap rally of late, optimism reigns supreme. All that’s need is supported economic data in the weeks and months ahead.

How is recession risk evolving? Monitor the outlook with a subscription to:
The US Business Cycle Risk Report

Macro Briefing: 19 January 2021

Tue, 19 Jan 2021 10:50:42 GMT

* Biden plans to unveil sweeping immigration bill on first day as president
* Yellen to promote “big” coronavirus relief package to Senate Fin. Comm. today
* Biden administration prepares to focus on full-employment policies
* German investor sentiment rises more than expected in January
* Extreme weather and infectious diseases are cited by WEO as top 2021 risks
* Pandemic has intensified rivalry between US and China, WEO report says
* 10-year Treasury yield begins trading this week at 1.11%, a 10-month high:

US Property Shares Led Returns For Major Asset Classes Last Week

Mon, 18 Jan 2021 12:07:23 GMT

US real estate investment trusts (REITs) remain range-bound but property shares managed to lead the major asset classes last week by a wide margin, based on a set of exchange traded funds at Friday’s close (Jan. 15).

Vanguard US Real Estate (VNQ) popped 1.9% last week, the fund’s strongest weekly gain since mid-November. A solid performance but the gain doesn’t break the ETF out of its trading range that’s prevailed for the past two-and-a-half months, as shown below in the chart of weekly returns.

Overall, the week just passed delivered mixed results for global markets, with a downside bias. The biggest setback was in foreign stocks in developed markets. Vanguard FTSE Developed Markets (VEA) slumped 1.9%, a relatively steep decline for last week’s trading results. Note, however, that the setback looks like noise in the context of VEA’s recent upside trend of late.

The Global Markets Index (GMI.F) retreated last week for the first time this year. This unmanaged benchmark, which holds all the major asset classes (except cash) in market-value weights via ETF proxies, slumped nearly 1%.

For the one-year window, US equities are still leading the major asset classes—by a small margin. Vanguard Total US Stock Market (VTI) closed last week with an 18.8% total return for the past 12 months. A close runner-up performer: shares in emerging markets via Vanguard Emerging Markets (VWO), which is up 16.9% for the trailing 12-month period.

The weakest one-year performers: US and foreign property shares, which are posting the only losses for this time window. Vanguard US Real Estate (VNQ) and its offshore counterpart (VNQI) are down 7.0% and 9.2%, respectively, vs. their year-ago levels after factoring in distributions.

GMI.F, by contrast, is up a strong 13.8% over the past year, a solid gain for this multi-asset-class benchmark.

Most of the major asset classes continue to post near-zero drawdowns. The downside outliers: foreign property shares (VNQI), government bonds in emerging markets (EMLC), US REITs (VNQ) and the biggest drawdown at the moment: broadly defined commodities (GCC), which closed on Friday with a 38.8% peak-to-trough decline.

GMI.F’s current drawdown is currently -1.0%.

Learn To Use R For Portfolio Analysis
Quantitative Investment Portfolio Analytics In R:
An Introduction To R For Modeling Portfolio Risk and Return
By James Picerno

Macro Briefing: 18 January 2021

Mon, 18 Jan 2021 11:03:43 GMT

* Biden plans rollbacks of Trump era policy decisions on Wednesday
* China reports 6.5% GDP growth for Q4 & and 2.3% for 2020
* Russian opposition leader Navalny’s arrest heightens Russia-West tensions
* Incoming Treasury Sec. Yellen expected to affirm market-based exchange rates
* Weak value investing results weigh on quant strategies
* US industrial output up a strong 1.6% in December
* NY Fed Mfg Index shows softer growth in January
* US retail sales fell for a third month in December:

Book Bits: 16 January 2021

Sat, 16 Jan 2021 13:05:29 GMT

● The New Great Depression: Winners and Losers in a Post-Pandemic World
James Rickards
Quote by author via Global Finance
“I did not live through the Great Depression, but my parents did and they were affected for life,” says James Rickards, author of The New Great Depression: Winners and Losers in a Post Pandemic World. “This will be very similar.” A 2020 study published by the Federal Reserve of San Francisco looked at 650 years of pandemics and found that monetary policy, economic growth and other policies do not normalize for 30 to 40 years. “If 2019 is your base year to define normal,” Rickards says, “well, we’ll never see normal again. Ever.”

● Freedom From the Market: America’s Fight to Liberate Itself from the Grip of the Invisible Hand
Mike Konczal
Review via Publishers Weekly
Roosevelt Institute director Konczal (coauthor, Rewriting the Rules of the American Economy) argues that “true freedom requires keeping us free from the market” in this persuasive and methodical account. Countering “glib libertarian fantasies” of American history, Konczal details cases where the federal government suppressed the free market for the benefit of society, including the 1862 Homestead Act, which allowed settlers to claim up to 160 acres of public land in the West. He also champions the work of FDR’s secretary of labor, Frances Perkins, who described unemployment benefits and Social Security as “another great step in that liberation of humanity,” and explores how President Lyndon Johnson used Medicare funding to force desegregation in Southern hospitals. According to Konczal, the project of ensuring “a free, broadly accessible system of higher education” in the U.S. was undermined in the 1960s and ’70s by debt crises and conservative politicians battling student protestors.

● The Plague Cycle: The Unending War Between Humanity and Infectious Disease
Charles Kenny
Review via Nature
An economist at the Center for Global Development in Washington DC, Charles Kenny (The Plague Cycle) takes [a long-term view of infectious diseases]. His starting point is a discussion of prehistoric humans’ susceptibility to disease, focusing on 2,500 years of civilization’s interaction with infections, especially in today’s urban societies. This is big-picture medical history. It takes in pestilence including plagues, malaria, smallpox and polio. It snapshots antibiotics and vaccines, and the problems of drug development, anti-vaccine campaigners and drug resistance. And he looks at social and medical reform, including sanitation, nutrition and the development of professional medical science and public-health systems. This all-encompassing view of humanity’s battles against disease provides a useful background to the more-specialized COVID-19 volumes.

● On My Radar: Navigating Stock Market Cycles
Stephen Blumenthal
Press release for book
Today’s investors are inundated with an endless stream of information. On My Radar cuts through the noise, providing an investment road map to help readers zero in on what matters most. Over his thirty-six-year career working with professional and individual investors, Blumenthal has witnessed first-hand how investors’ emotions and lack of a disciplined investment game plan—lead to poor outcomes. To combat these self-destructive tendencies, his book outlines his process-oriented investment approach to wealth creation while navigating the market cycles—whether bull or bear.

Please note that the links to books above are affiliate links with Amazon.com and James Picerno (a.k.a. The Capital Spectator) earns money if you buy one of the titles listed. Also note that you will not pay extra for a book even though it generates revenue for The Capital Spectator. By purchasing books through this site, you provide support for The Capital Spectator’s free content. Thank you!

The ETF Portfolio Strategist: 15 Jan 2021

Sat, 16 Jan 2021 01:43:50 GMT

In this issue:

The small-cap equity rally continues
Portfolio-strategy benchmarks take a hit
Broad-based market losses weigh on managed-risk strategies

Small-cap stocks are pricing in a rosy 2021: There are still plenty of risks lurking, including uncertainty over what the incoming Biden administration will be able to accomplish. The President-elect on Thursday outlined an ambitious $1.9 trillion pandemic relief program that, if enacted, would go a long way in juicing the economy. Whether his policy prescription survives the tortured politics of the Beltway in the weeks ahead is an open question. For now, shares in the small-cap realm appear to be anticipating a rosy year ahead (or at least one that compares favorably vs. annus horribilis that just ended).

continue reading at The ETF Portfolio Strategist

Research Review | 15 January 2021| Forecasting

Fri, 15 Jan 2021 12:12:48 GMT

Long-Term Stock Forecasting
Magnus Pedersen (Hvass Laboratories)
December 17, 2020
When plotting the relation between valuation ratios and long-term returns on individual stocks or entire stock-indices, we often see a particular pattern in the plot, where higher valuation ratios are strongly correlated with lower long-term stock-returns, and vice versa. Moreover the plots often show a particular curvature for this relation between valuation ratio and long-term stock-returns. The explanation turns out to be quite simple and follows directly from the mathematical definition of the annualized return. Furthermore, we can decompose the change in share-price into the change in valuation ratio such as the P/E or P/Sales ratio, and the change in the Earnings or Sales Per Share. This is intuitively obvious because the share-price simply equals the valuation ratio e.g. P/Sales multiplied by the Sales Per Share. Using this with the formula for annualized return, we get a fairly simple formula for estimating the future stock-returns, based on the current valuation ratio and our best guess for the future valuation ratio, and the future growth in e.g. Earnings or Sales Per Share, and the future Dividend Yield. This is the basis of the long-term forecasting model, for estimating the mean and standard deviation of future stock-returns. Although the forecasting model is “embarrassingly” obvious in hindsight, it has apparently never been formalized in any previous publications, which have merely studied the empirical relation between valuation ratios and long-term stock-returns, without giving a formal explanation why this relation exists, and how to use it properly for long-term forecasting. That is done in this paper and we will also show when and why the forecasting model does not work, using real-world data for both individual stocks as well as entire stock-indices such as the S&P 500, 400 and 600 for U.S. stocks, and various Exchange Traded Funds (ETF) for international stock-indices.

Towards a Better Fed Model
Raymond Micaletti
October 4, 2020
We present an alternative to the widely known and much-maligned “Fed model.” The proposed alternative makes a coherent comparison between equities and bonds that eliminates the theoretical and empirical flaws of the original (as well as any need for ad hoc asset-class volatility adjustments). The output of the model is a time-series value factor, which is then used to develop a tactical asset allocation strategy. Historical simulations suggest the resulting strategy is superior not only to the original Fed model, but to tactical strategies based on other popular time-series value factors as well. Beyond its forecasting and tactical allocation performance, the proposed model also provides significant insight into equity market dynamics–insight that has been validated by recent historical events.

The Probability of Recession: A Critique of a New Forecasting Technique
Noah Weisberger and Vishv Jeet (PGIM)
June 2020
A recent research publication develops a new business cycle forecasting technique using a metric called “Mahalanobis distance.” This measure is intuitive, is based on a straightforward set of computations, is able to identify post-war US recessions with few false positives, and, as claimed by the authors, has a reasonable forward hit rate. In late 2019, according to this new measure, the estimated probability that the US was in a recession had climbed to about 75%, a prediction that was at odds with many other models. However, by early 2020 and still prior to the pandemic, the measure’s probability of recession had retreated, falling below 3%, and remaining subdued through March. The measure’s volatility prompted a closer technical look into its strengths and weaknesses and its potential as a market timing tool.

Geo-Economics Chapter 5: My Rules of Forecasting
Joachim Klement (Fidante Partners)
January 5, 2021
Chapter 5 of Geo-Economics: The Interplay between Geopolitics, Economics, and Investments opens the second part of this book, in which I focus on geopolitical trends that might become important in the coming decade. To set the scene, Chapter 5 introduces my 10 rules of forecasting. Developed over years of practical application, these 10 rules have served me well in predicting both financial and political developments and can easily be adopted by every investor. They will also serve as the guiding principles in the discussion of the important geopolitical trends of our time.

Extreme Valuations and Future Returns of the S&P 500
Shaun Rowles and Andrew Mitchell
November 1, 2020
Higher than average Price-to-Earnings (P/E) ratios and Cyclically-Adjusted Price-to-Earnings (CAPE) ratios have been tolerated by investors recently on the basis of low interest and inflation rates. This white paper analyzes what level of returns can reasonably be expected going forward from today’s elevated valuation multiples.

Combining Forecasts: Can Machines Beat the Average?
Tyler Pike and Francisco Vazquez-Grande (Federal Reserve)
September 11, 2020
This paper documents benefits of combining forecasts using weights that depend non-linearly of past forecast errors. We propose combining out of sample forecasts from simple models using weights, computed using machine learning algorithms trained on the models’ past forecast errors. These nonlinear weights produce more accurate forecasts than conventional approaches based on equal-weighed forecasts, breaking the so-called “forecast combination puzzle”.

Time-Frequency Forecast of the Equity Premium
Gonçalo Faria (Catholic University of Portugal and Fabio Verona (Bank of Finland)
April 27, 2020
Any time series can be decomposed into cyclical components fluctuating at different frequencies. Accordingly, in this paper we propose a method to forecast the stock market’s equity premium which exploits the frequency relationship between the equity premium and several predictor variables. We evaluate a large set of models and find that, by selecting the relevant frequencies for equity premium forecasting, this method significantly improves in both statistical and economic sense upon standard time series forecasting methods. This improvement is robust regardless of the predictor used, the out-of-sample period considered, and the frequency of the data used.

Macro Briefing: 15 January 2021

Fri, 15 Jan 2021 10:53:05 GMT

* Biden outlines $1.9 trillion Covid-19 relief plan
* Today’s US retail sales data for December expected to post decline
* Economists expect US growth at 4.3% in 2021 via new survey
* Fed’s Powell says no rate hikes on the horizon for now
* New wave of Covid-19 outbreak in China threatens economic recovery
* UK double-dip recession lurks after GDP fell 2.6% in November
* Are renewable energy stocks in a bubble?
* Philly Fed’s ADS business cycle index falls sharply, signaling US recession risk
* US import prices rose more than expected in December
* US jobless claims surged last week to a 5-month high:

Has The Recent Surge In US Equity Factor Correlations Peaked?

Thu, 14 Jan 2021 12:40:21 GMT

Looking for robust diversification opportunities in equity risk factors has turned up modest and sometimes disappointing results in recent years in broad-brush terms and it’s only gotten worse in the pandemic. The question is whether the worst has passed? Possibly, although the outlook remains cautious at best. Let’s dig into the numbers for some details.

Recall that the goal is to decompose broad stock market beta into several flavors of the risk premia that, in the aggregate, capture the overall footprint of the asset class while dispensing lower risk, higher return or some combination of both vs. holding, say, the S&P 500 Index. By rebalancing the mix, it’s possible to exploit the natural ebb and flow of factors so that 1+1=3. That, at least, is the theory. Not surprising, it’s a tall order and putting it into practice and reaping substantial benefits is no mean feat.

To be fair, some slices of the various equity factors do outperform the broad market in absolute and risk-adjusted terms. But there’s also plenty of underperformers. Overall, it tends to be a wash and so simply holding everything and rebalancing back to a quasi-market weights probably won’t provide much value-added performance and/or risk reduction. You’ll almost certainly need to do more.

That leads to the main event: Which equity factors do you favor, which ones do you pan, and when? Like any attempt at deconstructing a broadly defined beta footprint and timing the choices, the answers are warm and fuzzy in real time.

“A multi-factor strategy is placing a lot of bets,” says Josh Russell, an analyst at Franklin Templeton Investment Solutions. “If all of these collapse into one unidirectional bet, you really lose your edge.”

The Bloomberg article that quotes Russell also presents data that shows that equity factor strategies “are failing to live up to their diversification label in an era when recession-spurring lockdowns, rally-inducing stimulus and game-changing vaccines are all moving markets.” The smoking gun: “Factor correlations have risen to the highest in at least two decades.”

As one example, strategists at Bernstein show that rolling six-month pairwise correlations of global long-short returns for four factors (value, quality, growth and momentum) are at two-decade highs. (Note: correlations range from +1.0, which is perfect positive correlation, to 0.0 or no correlation, and -1.0 perfect negative correlation.)

Keep in mind that you can show different results by changing the rolling period, measuring returns on a long-only basis and tweaking the factor list, to name a few of the possible adjustments that are standard fare with analytical explorations in this niche. With that in mind, let’s run the numbers from a different perspective by using a set of ETFs as proxies for the opportunity set:

Before we run the analysis in R, we’ll process the raw returns by subtracting a “risk-free” rate from the ETF performances. Representing the risk-free return: iShares Short Treasury Bond (SHV).

As a starting point, the chart below shows the median correlation of all the pairwise correlations for the ETFs in the table based on a rolling one-year window (252 trading days) through yesterday’s close (Jan. 13). It’s clear that correlations recently spiked, courtesy of the initial coronavirus shock last spring. Despite the best efforts of slicing and dicing equity factors, the market beta component overwhelmed those efforts and stocks of every stripe took a beating when the world shifted to risk-off in the extreme last March and April.

Let’s sort out the details in the table below, which shows all the pairwise combinations for tailing one-year window via daily returns. The good news is that there are some encouraging results. The lowest correlation is 0.58 for momentum (MTUM) and small-cap value (IJS). Mid-cap value (IJJ) and large-cap growth (IWF) also post a relatively modest correlation: 0.77.

Not surprisingly, the numbers change if we change the parameters. For instance, moving further out on the time window to one-year returns over the trailing 5-year period delivers the following:

On this basis, the opportunities look more encouraging. Indeed, the lowest correlation for the five-year window falls to just 0.27, once again for momentum (MTUM) and small-cap value (IJS).

It’s fair to say that it’s still premature to dismiss the idea that building an equity portfolio with factor building blocks has run out of road. As the numbers above suggest, the opportunities may fading and in short supply, but (at the risk of testing your tolerance for metaphor) the well has yet to run dry in this corner.

Nonetheless, the marketplace of equity factors is relatively efficient (most of the time) and so the best results on this front will likely deliver modest advantages over the broad market. There are just too many investors fishing in this lake (there I go again) to expect blowout results after adjusting for risk. But if you’re willing to put in the work and tolerate the not-trivial possibility of high tracking error vs. the market overall, you can find some degree of pay dirt (sorry) here. But be warned: your odds of success, which were never particularly higher in the best of circumstances, have slumped recently.

The good news: correlations aren’t static and what goes up tends to come down and it appears that the recent surge is pulling back. For some factor pairs, the potential diversification payoff could be substantial in 2021 and beyond. But it’s hardly a free lunch since the price tag for earning market-beating results is directly related to how far you’re willing to deviate from the standard equity market portfolio? For the average investor, it’s not an enticing proposition. That leads to the standard question: Are you average? If not, what does that imply? One possibility: customize your equity factor allocation.

Learn To Use R For Portfolio Analysis
Quantitative Investment Portfolio Analytics In R:
An Introduction To R For Modeling Portfolio Risk and Return
By James Picerno

Macro Briefing: 14 January 2021

Thu, 14 Jan 2021 10:55:05 GMT

* Trump impeached for Second Time with support of 10 Republicans
* Will Senate convict and remove Trump? Senate leader is undecided
* Biden set to unveil plan for new Covid-19 relief package today
* Federal officials warn of new attacks by extremists
* China exports rose more than expected in December
* China reports first Covid-19 death since May
* ECB President Christine Lagarde calls for global regulation of bitcoin
* US headline consumer inflation rose 1.4% 2020:

Philly Fed’s ADS Business Cycle Index Near A Recession Signal

Wed, 13 Jan 2021 12:33:32 GMT

Is the US economy at risk of a double-dip recession? The threat is rising, according to the latest update of the ADS Index, a real-time tracker of business conditions published by the Philadelphia Fed. This benchmark is a valuable metric for monitoring recession risk, but its attempt to be timely also leaves it vulnerable to noisy volatility. Nonetheless, the latest ADS slide in the current climate bears watching as the pandemic continues to roil America in the new year.

Last week’s weak payrolls data and the ongoing surge in weekly jobless claims took a hefty bite out of the ADS Index, which is updated whenever new data is published for any of its six components. Last week’s labor market numbers were brutal overall and ADS fell to just slightly above a level that marks recession conditions – the weakest reading for ADS since the economy began recovering in the summer from the initial coronavirus shock in the spring.

Learn To Use R For Portfolio Analysis
Quantitative Investment Portfolio Analytics In R:
An Introduction To R For Modeling Portfolio Risk and Return
By James Picerno

ADS tumbled sharply after last week’s economic updates, dropping to -0.73, which reflects data through Jan. 2. The index is currently just above the -0.80 mark that a San Francisco Fed paper identified as a level signaling recession conditions (red line in chart below).

Weighing on the latest downdraft in the ADS data is last week’s news that US payrolls declined in December for the first time in eight months. Meanwhile, new weekly filings for unemployment benefits continue to rise at an alarming rate. Claims increased 787,000 for the week through Jan. 2, which reflects a months-long run of advances that exceed the peaks in previous recessions.

The double-barreled release of dark labor market data cut the ADS index sharply. Is this a sign that a new phase of economic contraction is now baked in for the first quarter and perhaps beyond? Maybe not.

The case for optimism (or at least a lesser degree of pessimism) starts by recognizing that the ADS Index is a volatile beast and so it’s prone to false signals. Note, too, that when we run the raw ADS data through a probit model to estimate the implied level of recession risk the results still show a moderate threat, as indicated in the next chart below.

Meanwhile, the monthly updates of the Chicago Fed National Activity Index (particularly the three-month average) is a more reliable data set and for now this profile still shows a solid pace of growth. The challenge, however, is that the Chicago Fed data arrives with a longer lag. For example, the current Chicago Fed update is through November – ancient history in the current climate.

The tradeoff and stakes between timeliness and reliability for recession-risk monitoring is unusually stark at the moment — pick your poison. Despite the weak ADS readings, it’s still premature to assume that the economy is inevitably hurtling into a new run of recession. But that view could change in the immediate future, depending on how the incoming numbers stack up over the next several weeks.

As usual, key numbers driving expectations and real-world results is closely linked to the coronavirus. Unfortunately, the pandemic’s path of death and destruction is getting worse. This may be the last battle before relief arrives in the months ahead as vaccines are delivered more widely. But for now, the numbers are increasingly worrisome. In particular, the trend in the daily change in new US Covid-19 fatalities continues to surge, rising to a new record high yesterday (Jan. 12), based on data from Johns Hopkins University.

Key economic updates to watch in the days ahead: weekly jobless claims (released every Thursday), along with this Friday’s December data on retail sales (Jan. 15). Economists expect that consumer spending fell 0.1% last month, according to Econoday.com’s consensus forecast. If correct, the decline will mark the third straight monthly slide.

For now, the current ADS warning is a reminder that the US economy’s expansion is struggling. The rollout of a vaccine will bring relief, but significant improvement on this front is still months away due to a slow and sometimes erratic distribution program.

Meantime, the US economy is increasingly vulnerable. Another batch of weak numbers for key indicators in the weeks ahead could formally trigger a new recession. Even if the business cycle turns negative, again, it may be a short affair. Nonetheless, the risk is greater compared with previous recessions as long as the uncertainty of Covid-19 stalks the land and unprecedented numbers of workers continue to lose their jobs week after week.

How is recession risk evolving? Monitor the outlook with a subscription to:
The US Business Cycle Risk Report

Macro Briefing: 13 January 2021

Wed, 13 Jan 2021 11:13:01 GMT

* Growing list of Republicans will support today’s vote on impeaching Trump
* Pence rejects effort to oust Trump with 25th amendment
* US to require proof of negative Covid-19 tests for international visitors
* China’s Covid-19 cases rise the most in over five months
* Brazil data shows China coronavirus vaccine is 50.4% effective
* Global shortage of semiconductors squeezes auto production
* US job openings fell less than expected in November but still trending down
* US small business optimism index fell sharply in December:

What Do Rising Interest Rates Imply For Stocks, REITs And Gold?

Tue, 12 Jan 2021 12:57:45 GMT

The world is still battling a pandemic, the US government is in turmoil and there’s no shortage of other events lurking on the global stage that could cause trouble for asset markets. Should we add in rising interest rates to the list of worries?

“Markets are now definitely pricing in rate hikes by the second half of 2023, but the time frame is a long way away and it will keep shifting, especially if the US continues to lose jobs as they did in December,” says Kenneth Broux, a strategist at Societe Generale in London.

The future is still uncertain, but rates are clearly rising, albeit from an unusually low base. It’s unclear if the rise is one more in a line of temporary upside runs in an otherwise secular decline. Analysts have been predicting the end of the slide in yields for several decades and they’ve been wrong every time. Is this time different? Maybe, but the jury’s still out and it’ll take several months at the least to develop convincing evidence to the contrary.

Meantime, let’s take a quick look at the relationship between the benchmark 10-year Treasury yield vs. benchmarks for three asset classes that tend to figure prominently in asset allocation strategies: US stocks, US real estate investment trusts (REITs) and gold. The other broad brush measure of conventional asset classes (bonds) needs no analysis since rising rates, by definition, translate to falling prices for fixed-income securities.

Let’s begin by looking at the recent trend in the 10-year rate. As the chart below shows, there’s been a clear upside break in recent months. The rise to 1.15% yesterday (Jan. 11) marks the highest level since last March. The increase in the rate’s 50-day moving average above the 200-day average late last year suggests that a strong upside bias will persist for the near term.

Now we turn to the relationship between stocks and the 10-year rate. There are many ways to model this relationship and what follows is barely dipping our statistical toes into the ocean of possibility. But every analytical journey has to start somewhere, and as a quick look into the relationship it’s reasonable to ask: How do one-year rolling changes compare?

Glad you asked. The next chart offers some preliminary insight by comparing the percentage changes in the 10-year yield vs. a benchmark for US stock prices (Wilshire 5000 Index). The main takeaway: there’s a tight relationship — sometimes. But the two are hardly joined at the hip through time. In fact, the relationship is quite weak over the full history since 1980. The correlation for the two monthly data sets is roughly 0.13, which is close to zero, meaning that there’s no reliable relationship to speak of.

Viewing the same data in a scatterplot confirms that the 1980-2019 results strongly suggest that the link between changes in the 10-year rate and the US stock market over one-year windows is thin.

Part of the reason for the shifting relationship is economic. Identifying the macro reasons for why interest rates are rising or falling is critical for assessing the likely impact on stock prices. As a simple example: if rates are rising because economic growth is picking up, that’s likely to be relatively bullish for stocks. By contrast, if rates are rising because the central bank is trying counter hotter inflation, it’s reasonable to assume that this isn’t great news for the equity market.

Note, however, that over some periods the connection is tight. For example, in the period leading up to, through, and immediate after the 2008-2009 economic recession, the changes in the 10-year rate and equities were highly correlated. That is, stock prices tanked along with the 10-year rate going into the recession. The opposite unfolded as the economic contraction ended.

Keep in mind that other time windows will show different results. But for this initial look at rolling 1-year changes the numbers overall suggest that we should be cautious before deciding that higher interest rates alone are a high-confidence reason to expect that stock prices will dive (or rise, for that matter).

How does the 10-year yield relationship compare with REITs? Given that property shares (Wilshire REIT Index) are highly prized for relatively high payouts implies that there will be a stronger negative correlation with Treasury yields. In fact, monthly data for one-year changes isn’t all that different than the connection for stocks. Although REIT returns and the 10-year yield are closely connected at times, overall the relationship reflects a correlation of about 0.10. One reason may be that equity beta dominates REIT pricing vs. the property factor.

Finally, here’s how 1-year changes for gold stack up against the 10-year yield. Here, too, the relationship is mixed and so it’s risky to draw hard and fast conclusions. The correlation between the two is slightly negative but still close to zero. Although gold is influenced by interest rates, the economic and financial context matters, perhaps a lot.

The analysis above suggests caution in assuming that a rising 10-year Treasury yield is a strong factor for predicting near-term returns in stock, REITs and gold. Interest rates are obvious a key variable for developing expectations about expected return, but looking at it in isolation doesn’t offer a silver bullet, at least not for the 1-year horizon. Ideally, the relationships above would reflect strong negative or positive correlations, which in turn would provide confidence about projecting returns. But the numbers suggest otherwise.

But let’s not be too hasty. The lack of traction in the simple analysis above is hardly definitive. Reality is more nuanced, starting with the observation that the 10-year rate’s influence ebbs and flows, depending on the economic conditions and the time horizon and that’s not always obvious over long periods of time.

This preliminary step in analyzing how the 10-year rate interacts with other markets is a reminder that the connection between interest rates and asset classes is complicated. That’s different than saying it’s irrelevant. Unfortunately, mapping this relationship requires a deeper dive than comparing rolling one-year changes.

Learn To Use R For Portfolio Analysis
Quantitative Investment Portfolio Analytics In R:
An Introduction To R For Modeling Portfolio Risk and Return
By James Picerno

Macro Briefing: 12 January 2021

Tue, 12 Jan 2021 11:06:56 GMT

* House will vote today on removing Trump with 25th amendment
* House plans Trump impeachment vote for Wednesday
* Acting Homeland Security Secretary quits as FBI warns of armed protests
* Secretary of State Pompeo puts Cuba on terrorism sponsor list
* Atlanta Fed President sees possible rate hike coming sooner than expected
* China’s rebounding economy is strengthening its currency
* Double-dip recession risk is stalking Europe
* Bitcoin’s dramatic correction is healthy, say analysts
* Consumer year-ahead inflation expectations remain unchanged in December
* 10-year Treasury yield continues to tick higher, rising to 1.15%:

Foreign Stocks Led Mixed Run For Global Markets Last Week

Mon, 11 Jan 2021 12:03:34 GMT

Shares in emerging markets topped last week’s gains for the major asset classes, based on a set of exchange traded funds as of Friday’s close (Jan. 8). Equities in developed markets ex-US were a close second-place weekly performer.

Leading the winners: Vanguard FTSE Emerging Markets Shares (VWO), which surged 4.7% last week. The rally lifted the fund to a record high. The latest gain marks the fund’s strongest weekly advance since the first week of November.

“There’s a lot of opportunity, a lot of risks, but I think emerging markets are really attractive right now,” says Ben Kirby, co-portfolio manager of Thornburg Investment Income Builder Fund. “Emerging market cycles tend to last several years,” he told CNBC on Friday. “Emerging markets have underperformed for quite a few years until last quarter, and emerging markets outperformed in a bull market. That’s interesting to us, so we think we’re probably at the early innings of what could be a sustained period of emerging market outperformance.”

But Henrik Gullberg, a macro-economist at Coex Partners in London, says rising US interest rates pose a challenge. “For emerging markets, higher US yields are a negative, so markets need to hear from the Fed that they will not tolerate an excessive rise,” advises Henrik Gullberg, a macro economist at Coex Partners in London.

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Despite the rally in stocks last week (US equities were the third-best performer), most slices of the major asset classes lost ground. The biggest loser: US real estate investment trusts (REITs). Vanguard US Real Estate (VNQ) sunk 2.2%, it’s first weekly decline in a month.

The Global Markets Index (GMI.F) rose for a second week, rallying 1.9%. This unmanaged benchmark holds all the major asset classes (except cash) in market-value weights via ETF proxies.

For the one-year window, US equities are still leading the major asset classes. VTI ended last week’s trading with a 22.9% total return for the past 12 months. That’s moderately ahead of the second-best one-year performer: stocks in emerging markets via VWO, which is up 19.7%.

US and foreign property shares continue to post the only losses for one-year results. Vanguard US Real Estate (VNQ) and its offshore counterpart (VNQI) are down 5.6% and 6.3%, respectively, vs. their year-ago levels after factoring in distributions.

GMI.F is up a strong 16.0% over the past year, an unusually bullish gain for a multi-asset-class index relative to history.

Ranking global markets by current drawdown continues to show that stocks, led by US shares (VTI), are leading in this corner with zero peak-to-trough declines.

At the opposite end of the spectrum: broadly defined commodities: WisdomTree Continuous Commodity Index Fund (GCC) continues to post a steep peak-to-trough slide of nearly -39%.

GMI.F’s current drawdown is zero.

How is recession risk evolving? Monitor the outlook with a subscription to:
The US Business Cycle Risk Report

Macro Briefing: 11 January 2021

Mon, 11 Jan 2021 11:06:48 GMT

* House set for new impeachment vote on Trump
* Authorities prepare for more protests and possible violence in Washington
* Wall Street strategists anticipate reflation momentum picking up
* Will 2021 be a record year for job growth in the US?
* Philly Fed’s ADS Index moves close to signaling US economic contraction
* US payrolls declined in December–first monthly slide in 8 months
* US 10-year Treausury yield rises to 1.13%–highest since March:

Book Bits: 9 January 2021

Sat, 09 Jan 2021 13:14:55 GMT

● Driven: The Race to Create the Autonomous Car
Alex Davies
Review via Berkeleyside
It may be a stretch to call Davies’ new book The Right Stuff for the Age of the Autonomous Vehicle, but it shares some of Tom Wolfe’s narrative exuberance, pioneer spirit and eye for the telling detail. Davies chronicles the tech industry’s fascination with self-driving vehicles, from their origins in three “Grand Challenges” sponsored by the Defense Advanced Research Projects Agency (DARPA) to the attempts by Google, Uber and the city of Detroit to exploit the innovative technology for the auto-buying public.

● China and the WTO: Why Multilateralism Still Matters
Petros C. Mavroidis and Andre Sapir
Summary via publisher (Princeton U. Press)
China’s accession to the World Trade Organization (WTO) in 2001 was rightly hailed as a huge step forward in international cooperation. However, China’s participation in the WTO has been anything but smooth, with China alienating some of its trading partners, particularly the United States. The mismatch between the WTO framework and China’s economic model has undermined the WTO’s ability to mitigate tensions arising from China’s size and rapid growth. What has to change? China and the WTO demonstrates that unilateral pressure, by the United States and others, is not the answer. Instead, Petros Mavroidis and André Sapir show that if the WTO enacts judicious reforms, it could induce China’s cooperation, leading to a renewed confidence in the WTO system.

● Alternative Data: Capturing the Predictive Power of Big Data for Investment Success
Mani Mahjouri
Summary via publisher (Wiley)
Alternative Data opens a gateway to the future of investing, using Open Halo technology to provide real-time performance analysis and breathtaking data visualization. Once solely available to the elites, this technology utilizes observational and transactional data covering vast numbers of stocks to analyze and forecast a company’s performance, often months ahead of any official announcement. This book shows you how to leverage this capability to make smarter investment decisions and predict market moves based on much more than conjecture.

● Crypto Asset Investing in the Age of Autonomy: The Complete Handbook to Building Wealth in the Next Digital Revolution
Jake Ryan
Summary via publisher (Wiley)
Crypto is the mechanism that will accrue value from being the infrastructure for the next digital financial revolution. Crypto Asset Investing lays out a case that we’ve begun a new technological revolution similar to the Internet Age of the 1990’s. Artificial intelligence, the Internet of Things, robotics and cryptocurrency are converging to deliver on a new age, what I call the Age of Autonomy. Understanding the transformation that’s taken place before anyone else can yield enormous investment opportunity. In this book, you’ll learn how and why to invest in crypto assets.

● Buffett’s Tips: A Guide to Financial Literacy and Life
John M. Longo
Q&A with author via Newswise
Q: How can a person move from financially ignorant to financially literate?
A: Living within your means is the most important step to building long-term wealth. We have all read about multi-millionaire athletes and celebrities who eventually went bankrupt, so it is not just about having a high income. Building wealth involves avoiding high interest rate credit cards, obtaining a good credit rating and investing for the long-term. For most people, owning stock is a great way to build wealth over the long-term, but you have to stick with it and not be shaken out during the inevitable market gyrations.

● Work Disrupted: Opportunity, Resilience, and Growth in the Accelerated Future of Work
Jeff Schwartz
Summary via publisher (Wiley)
The future of work swept in sooner than expected, accelerated by Covid-19, creating an urgent need for new maps, new mindsets, new strategies– and most importantly, a trusted guide to take us on this journey. That guide is Jeff Schwartz. A founding partner of Deloitte Consulting’s Future of Work practice, Schwartz brings clarity, humor, wisdom, and practical advice to the future of work, a topic surrounded by misinformation, fear, and confusion. With a fundamental belief in the power of human innovation and creativity, Schwartz presents the key issues, critical choices, and potential pitfalls that must be on everyone’s radar.

● Exotic Alternative Investments: Standalone Characteristics, Unique Risks and Portfolio Effects
Kevin R. Mirabile
Summary via publisher (Anthem Press)
This book evaluates new opportunities such as life settlements, litigation funding, farmlands, royalties, weather derivatives, collectables and other unique asset classes. It provides an in-depth analysis of the returns, risks, opportunities and portfolio effects for investors, advisors and academics and anyone who wants to expand their investment horizons.

● Consequences of Capitalism: Manufacturing Discontent and Resistance
Summary via publisher (Haymarket Books)
Noam Chomsky and Marv Waterstone
Is our “common sense” understanding of the world a reflection of the ruling class’s demands of the larger society? If we are to challenge the capitalist structures that now threaten all life on the planet, Chomsky and Waterstone forcefully argue that we must look closely at the everyday tools we use to interpret the world. Consequences of Capitalism make the deep, often unseen connections between common sense and power. In making these linkages we see how the current hegemony keep social justice movements divided and marginalized. More importantly, we see how we overcome these divisions.

● Capitalism and the Sea: The Maritime Factor in the Making of the Modern World
Liam Campling
Summary via publisher (Verso Books)
The global ocean has through the centuries served as a trade route, strategic space, fish bank and supply chain for the modern capitalist economy. While sea beds are drilled for their fossil fuels and minerals, and coastlines developed for real estate and leisure, the oceans continue to absorb the toxic discharges of our carbon civilisation—warming, expanding, and acidifying the blue water part of the planet in ways that will bring unpredictable but irreversible consequences for the rest of the biosphere.

The ETF Portfolio Strategist: 8 Jan 2021

Sat, 09 Jan 2021 01:56:31 GMT

In this issue:

The stock market shrugs off Capitol chaos
A bullish start for strategy benchmarks in the new year
Diverging paths for managed risk strategies

Is Insurrection Bullish? Let’s just say that judging by the week just ended, the stock market isn’t easily shaken by such distractions as riots in the US Capitol or political turmoil in Washington.

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