Shares in emerging markets led the winners in an otherwise mixed run of trading for the major asset classes last week, based on a set of ETFs through Friday’s close (Jan. 14).

Vanguard Emerging Markets (VWO) rose 2.6%, lifting the fund for a third week in the past four. At Friday’s close, VWO was close to its highest level in two months.

Despite the recent strength, VWO still looks caught in a trading range. Recent strength in commodities prices is helping lift EM shares – many countries in this space rely on exports of raw materials. But the outlook for these countries remains challenged for 2022, some analysts predict.

“Rising inequality and security challenges are particularly harmful for developing countries,” advises World Bank President David Malpass. Earlier this month, the bank

Nonetheless, firmer commodities prices could be a boost for some emerging markets. WisdomTree Commodity Index (GCC) continued to push higher last week, rising 2.2%, raising the ETF to near its highest close in almost three months.

Rising tensions between Russia and Ukraine are reportedly a factor that’s been lifting the commodities markets lately. “Odds of a military action in Ukraine rose on Jan. 13 as Russia concluded a week of ‘unsuccessful’ talks by warning diplomacy could soon end,” says Paul Sheldon, chief geopolitical adviser for S&P Global Platts Analytics.

Warren Patterson, head of commodities strategy at ING, explains that a Ukraine-Russia conflict could create disruptions to commodity flows. He adds that the US and European Union may be drawn into any conflict and that new sanctions on Russia could trigger an “impact on the supply of a number of commodities to world markets.” These risks aren’t currently priced into the market, he opines.

Despite a number of winners last week, several slices of the major asset classes lost ground. The biggest loser: US real estate investment trusts (REITs): Vanguard Real Estate (VNQ) fell for a second week, shedding 1.4%.

The Global Market Index (GMI.F) was fractionally lower last week. This unmanaged benchmark (maintained by CapitalSpectator.com) holds all the major asset classes (except cash) in market-value weights via ETF proxies.

Ranking the major asset classes based on the trailing one-year trend continues to put US real estate at the head of the pack. VNQ is up nearly 35% over the past 12 months – well ahead of the rest of the field.

Foreign bonds are currently the weakest performers. The deepest loss at the moment among our proxy ETFs: SPDR Bloomberg Barclays International Treasury Bond (BWX), which is down 8.9% for the past year as of Friday’s close.

GMI.F’s one-year return is a solid 11.1% total return.

Profiling markets based on current drawdown continues to show that most of the major asset classes are reporting peak-to-trough declines of 10% of less. The big downside outlier: commodities (GCC), which ended last week at 25% under its previous peak.

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

* Omicron and inflation weigh on US economic outlook
* China’s zero-tolerance Covid policy is a risk factor for global manufacturing
* China GDP rose 4.0% in Q4 vs. year-ago level–slowest rise in nearly two years
* China central bank cuts interest rates to offset growth risk
* Oil price near highest level in more than six years
* N. Korea fires 2 missiles–fourth test this month
* Q4 earnings in focus this week: Will value and cyclicals outperform tech?
* US retail sales fell in Dec. (seasonally adj), but unadjusted data shows a surge:

● The Lords of Easy Money: How the Federal Reserve Broke the American Economy
Christopher Leonard
Excerpt via Politico
Between 2008 and 2014, the Federal Reserve printed more than $3.5 trillion in new bills. To put that in perspective, it’s roughly triple the amount of money that the Fed created in its first 95 years of existence. Three centuries’ worth of growth in the money supply was crammed into a few short years. The money poured through the veins of the financial system and stoked demand for assets like stocks, corporate debt and commercial real estate bonds, driving up prices across markets. Hoenig was the one Fed leader who voted consistently against this course of action, starting in 2010. In doing so, he pitted himself against the Fed’s powerful chair at the time, Ben Bernanke, who was widely regarded as a hero for the ambitious rescue plans he designed and oversaw.

● Driverless Finance: Fintech’s Impact on Financial Stability
Hilary J. Allen
Summary via publisher (Oxford U. Press)
Everyone is talking about fintech, and they’re usually saying good things. Driverless Finance provides a balance to that conversation, exploring the threats that different fintech innovations pose for our financial system. With in-depth and accessible descriptions of new financial technologies and business models – ranging from distributed ledgers to machine learning, cryptoassets to robo-investing – this book allows readers to think more critically about fintech, and about how the law should respond to it.

● Making Numbers Count: The Art and Science of Communicating Numbers
Chip Heath and Karla Starr
Summary via publisher (Simon & Schuster)
Understanding numbers is essential—but humans aren’t built to understand them. Until very recently, most languages had no words for numbers greater than five—anything from six to infinity was known as “lots.” While the numbers in our world have gotten increasingly complex, our brains are stuck in the past. How can we translate millions and billions and milliseconds and nanometers into things we can comprehend and use? Author Chip Heath has excelled at teaching others about making ideas stick and here, in Making Numbers Count, he outlines specific principles that reveal how to translate a number into our brain’s language.

● The Capitalist and the Activist: Corporate Social Activism and the New Business of Change
Tom C. W. Lin
Review via Kirkus Reviews
A legal scholar examines the growing phenomenon of corporate activism.
In this debut book, Lin—a law professor at Temple University and Academic Fellow at George Washington University’s Center for Law, Economics & Finance—suggests that “too often the stories of activists and capitalists are told as disparate, unrelated stories of distinct tribes.” With an expert’s grasp on current trends in corporate America, the author instead sees the “new reality of corporate social activism” and the “interplay between capitalists and activists” as an important 21st-century development. Nearly every major corporation, for instance, has formal “social responsibility programs,” and Fortune 500 companies have pumped billions of dollars into these campaigns since 2020 alone.

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 Time-Varying Relation between Stock Returns and Monetary Variables
David G. McMillan (University of Stirling)
November 2, 2021
The nature of the relation between stock returns and the three monetary variables of interest rates (bond yields), inflation and money supply growth, while oft studied, is one that remains unclear. We argue that the nature of the relation changes over time and this variation is largely driven by shocks, with a change in risk associated with each variable shifting the pattern of behaviour. We show a change in the correlation between each of the three variables with stock returns. Notably, a predominantly negative correlation with bond yields and inflation becomes positive, while the opposite is true for money supply growth. The shift begins with the bursting of the dotcom bubble but is exacerbated by the financial crisis. Results of predictive regressions for stock returns also indicate a switch in behaviour. Predominantly negative predictive power switches temporarily to positive around economic shocks. This suggests that higher yields, inflation and money growth typically depress returns but support the market during periods of stress. However, after the financial crisis, higher inflation and money growth exhibit persistent positive predictive power and suggests a change in the risk perception of higher values.

Determinants of Inflation Expectations
Richhild Moessner (Bank for International Settlements)
December 2021
This paper analyses the determinants of short-term inflation expectations based on surveys of professionals, using dynamic cross-country panel estimation for a large number of 34 OECD economies. We find that food consumer price inflation and depreciations of the domestic exchange rate have significant positive effects on professionals’ survey-based inflation expectations. Moreover, core consumer price inflation and the output gap have significant positive effects.

The zero lower bound on inflation expectations
Yuriy Gorodnichenko (U. of California) and Dmitriy Sergeyev (Bocconi University)
January 11, 2022
Inflation expectations affect the decisions of households, firms, and policymakers. Expectations of negative inflation can be particularly harmful and lead to deflationary spirals when nominal interest rates are near zero. This column uses survey evidence to show that households and firms almost never expect deflation, even when it is a clear possibility. This apparent zero lower bound on inflation expectations has important implications for macroeconomic dynamics and the effectiveness of monetary policy. Unconventional policies, such as forward guidance, which aim to increase inflation expectations may be less effective when expectations are stuck at the zero lower bound.

The Impact of Rising Oil Prices on U.S. Inflation and Inflation Expectations in 2020-23
Lutz Kilian and Xiaoqing Zhou (Dallas Fed)
November 1, 2021
Predictions of oil prices reaching $100 per barrel during the winter of 2021/22 have raised fears of persistently high inflation and rising inflation expectations for years to come. We show that these concerns have been overstated. A $100 oil scenario of the type discussed by many observers, would only briefly raise monthly headline inflation, before fading rather quickly. However, the short-run effects on headline inflation would be sizable. For example, on a year-over-year basis, headline PCE inflation would increase by 1.8 percentage points at the end of 2021 under this scenario, but only by 0.4 percentage points at the end of 2022. In contrast, the impact on measures of core inflation such as trimmed mean PCE inflation is only 0.4 and 0.3 percentage points in 2021 and 2022, respectively. These estimates already account for any increases in inflation expectations under the scenario. The peak response of the 1-year household inflation expectation would be 1.2 percentage points, while that of the 5-year expectation would be 0.2 percentage points.

Measuring U.S. Core Inflation: The Stress Test of COVID-19
Laurence Ball (Johns Hopkins University), et al.
December 1, 2021
Large price changes in industries affected by the COVID-19 pandemic have caused erratic fluctuations in the U.S. headline inflation rate. This paper compares alternative approaches to filtering out the transitory effects of these industry price changes and measuring the underlying or core level of inflation over 2020-2021. The Federal Reserve’s preferred measure of core, the inflation rate excluding food and energy prices, has performed poorly: over most of 2020-21, it is almost as volatile as headline inflation. Measures of core that exclude a fixed set of additional industries, such as the Atlanta Fed’s sticky-price inflation rate, have been less volatile, but the least volatile have been measures that filter out large price changes in any industry, such as the Cleveland Fed’s median inflation rate and the Dallas Fed’s trimmed mean inflation rate. These core measures have followed smooth paths, drifting down when the economy was weak in 2020 and then rising as the economy has rebounded.

Feeling the Heat: Extreme Temperatures and Price Stability
Donata Faccia (European Central Bank), et al.
December 1, 2021
We contribute to the debate surrounding central banks and climate change by investigating how extreme temperatures affect medium-term inflation, the primary objective of monetary policy. Using panel local projections for 48 advanced and emerging market economies (EMEs), we study the impact of country-specific temperature shocks on a range of prices: consumer prices, including the food and non-food components, producer prices and the GDP deflator. Hot summers increase food price inflation in the near term, especially in EMEs. But over the medium term, the impact across the various price indices tends to be either insignificant or negative. Such effect is largely non-linear, being more significant for larger shocks and at higher absolute temperatures. We also provide simulations from a two-country model to understand the rationale behind the results. Overall, our results suggest that temperature plays a non-negligible role in driving medium-term price developments. Climate change matters for price stability.

The Rise of the Taylor Principle
Carlos Goncalves (IMF) and Bernardo Guimaraes (FGV)
December 9, 2021
We estimate the response of interest rates to inflation using data for 18 developed countries since 1915, within 30-year moving windows. Until 1972, interest rates are virtually insensitive to inflation. From then on, the interest-rate response to inflation starts to rise, and monetary policy responses get more heterogeneous across countries. In recent decades, all countries in the sample seem to abide by the Taylor Principle. We then take advantage of the observed policy heterogeneity in parts of our sample to estimate the effectiveness of the Taylor Principle. We run panel regressions of inflation volatility on the interest-rate response to inflation with country- and time- effects. We find that a stronger monetary policy response to inflation leads to lower inflation volatility.

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

* Supreme Court blocks Biden virus mandate for big firms
* Russia says Ukraine talks at ‘dead end’
* Hack attack brings down government web site in Ukraine
* Omicron persuades economists to cut US growth outlook for Q1
* Veteran Wall St economist–“Dr Doom”–criticizes Fed policy re: inflation
* China trade surplus with US rose for second year in 2021
* Global surge in energy demand may lead to more market volatility, IEA warns
* US producer price inflation up 9.7% last year–highest since 2010
* US jobless claims rose last week to highest level since November:

Does US market action in January set the tone for the rest of year? If it does, the investment gods will favor shares in the energy sector and stocks with relatively high dividend yields in 2022, courtesy of strong runs for both slices of the market so far this month, based on a set of ETFs.

“January returns have predictive power for market returns over the next 11 months of the year,” advises a study in the Journal of Financial Economics. A number of other researchers have reported similar results.

Can it be that easy? Buy January’s winners and take the rest of the year off? Even if that’s true, the month has isn’t yet half over and so caveat emptor. Indeed, even something that’s generally true in markets can go horribly wrong for any single time window.

In any case, put your editor down as skeptical that January’s performance is a magic bullet. Then again, there’s no charge for looking.

Let’s start with the broad US equity market: Using SPDR S&P 500 (SPY) as the benchmark, the kick-off to 2022 is wobbly. After an early pop, SPY’s month-to-date performance slumped and is currently under water by 0.8% year to date through yesterday’s close (Jan. 12). On that basis, equities are struggling with headwinds. But slicing and dicing stocks by sectors and risk factors offers a more nuanced view.

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

Energy shares are leading US equity sectors by a wide margin so far in 2022. Energy Select Sector SPDR (XLE) is up a sizzling 14.1% year to date. That’s more than double the performance for the second-best sector: financials via Financial Select Sector SPDR (XLF), which is ahead by 6.1% this month.

Energy’s strong start this year is all the more impressive when you consider that it was the top-performing equity sector last year. Note, too, that energy also led the field in January 2021, providing support for advocates of the January effect.

Meanwhile, the worst-performing equity sector so far in January: real estate shares. Real Estate Select Sector SPDR (XLRE) has shed more than 5% so far this month.

Powering the bull run in energy is a hot market for oil and gas prices. “If oil is on the rise and natgas is on the rise, it is going to mean an increase in earnings for those companies that are involved in the energy sector,” says Robert Pavlik, senior portfolio manager at Dakota Wealth Management. Mr. Market seems to agree and is already pricing in expectations for a strong run of earnings reports in the oil patch.

Profiling the US equity market by way of risk factors offers a different perspective. On this front, stocks with relatively high dividend payouts are leading the bulls. Then again, perhaps this is no coincidence given that energy shares tend to offer relatively high payouts. Whatever the driver, Vanguard High Dividend Yield (VYM) is up 2.6% in January, well ahead of the stock market overall and the other major risk factor slices for stocks.

One of the narratives favoring shares with relatively high payouts is the expectation that dividends will offset inflation. That assumes that dividends can grow faster than inflation. By some estimates, that’s a reasonable bet.

Matthew Treskovich, chief investment officer at CPS Investment Advisors, writes: “Over the past sixty years, the growth of dividends has beaten inflation by a wide margin.” Whether that remains true is debatable, but for the moment the market appears inclined to give this view the benefit of the doubt — no trivial matter at a time when inflation has surged and investors are searching for hedging opportunities.

“Dividend stocks are protected against inflation, because firms have been able to raise their prices, their cash flows, and increase their dividends,” advises Wharton School finance professor Jeremy Siegel. “I think that’s what investors are going to seek in 2022.”

By contrast, growth stocks generally are having a rough time so far this month. After running hot in 2021, the growth factor has suffered a reversal of fortunes in January. The deepest cut is in mid-cap growth (IJK), which is in the red by nearly 4%.

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

* Fed’s Lael Brainard to tell Congress that cutting inflation is top priority
* Seek out companies with strong pricing power as inflation hedge, advises analyst
* US economy grew at modest pace in closing weeks of 2021: Fed Beige Book
* Russia is cause for Europe’s worsening natural gas crisis, IEA charges
* Grocery-store shortages are back, due to several causes
* Firms’ year-ahead inflation expectations steady in January at 3.4% (avg)
* Oil rally expected to continue in 2022, analysts predict
* US consumer inflation accelerated to 7% in December, a 40-year high:

The US economy remains on track to post a sharp rebound in the fourth-quarter GDP report that’s scheduled for Jan. 27. The momentum, however, is expected to slow in early 2022 amid stronger macro headwinds.

Output in last year’s final quarter is on track to rise at a seasonally adjust annual 6.8% pace, based on the median estimate for a set of nowcasts compiled by CapitalSpectator.com — down slightly from the previous estimate in late-December. The expected gain marks a sharp improvement over Q3’s 2.3% increase.

The surge in growth relative to Q3 isn’t expected to last. Several factors are likely to weigh on the macro trend in this year’s first quarter, including ongoing supply-chain constraints and fallout linked to the recent spread of the Omicron variant of the coronavirus.

“We’re getting a sense that there are a lot of infections, but it’s not going to, in all likelihood, overwhelm us. But how long is it going to be around? Because that is disruptive,” says Mark Zandi, chief economist at Moody’s Analytics.  

Tighter monetary policy is also a reason to lower growth forecasts relative to Q4’s rebound. Federal Reserve Chairman Jerome Powell on Tuesday laid out a framework for raising interest rates this year. “As we move through this year … if things develop as expected, we’ll be normalizing policy, meaning we’re going to end our asset purchases in March, meaning we’ll be raising rates over the course of the year,” he told the US Senate Committee on Banking, Housing and Urban Affairs “At some point perhaps later this year we will start to allow the balance sheet to run off, and that’s just the road to normalizing policy.”

A pullback in fiscal stimulus is also a factor for managing expectations down for this year’s economic activity. “Peak fiscal policy support, and therefore peak real GDP growth, was likely realized in 2021, and the global economy now appears to be rapidly progressing toward late-cycle dynamics,” predicts PIMCO, an investment firm.

The main focus at the moment is on expectations for interest rate hikes. There’s a wide variety of outlooks on how far and how fast the Fed will life its target rate, which is currently set at a 0%-to-0.25% range. Fed funds futures are currently pricing in a 79% probability that the central bank will announce its first hike at the March 16 FOMC meeting, based on numbers published by CME Group.

Goldman Sachs sees several more increases later in the year. By some accounts, the Fed will be playing catch-up as it seeks to normalize policy in the wake of a sharp runup in inflation. In turn, the shift in monetary posture is a threat to economic growth, according to some analysts.

“Recessionary pressure is building,” says Jeffrey Gundlach, who oversees DoubleLine, a money manager. The Fed “seems pretty far behind the curve when you consider wage growth,” he advises. “We’re going to be more on recession watch than we have been.”

Perhaps, but recession risk remains low at the moment, based on analysis in this week’s issue of The US Business Cycle Risk Report. Economic momentum looks set to slow in early 2022, based on current estimates of the newsletter’s Economic Trend Index (ETI) and Economic Momentum Index (EMI) through February. But softer growth doesn’t yet translate into elevated recession risk: both indexes are expected to remain well above their tipping points (50% and 0%, respectively) that reflect neutral levels for economic activity.

The wild card is inflation and how the Fed reacts. But for the near term, the US economy remains on track to grow, albeit at a slowing pace. Now-casting.com’s current estimate for Q1 is 3.2% (as of Jan. 7), which is roughly half the expected rise for Q4.

Deciding what happens in the months ahead is still highly uncertain. The one relatively high-confidence view at the moment is that 2022 will unfold with decelerating growth momentum and several risk factors lurking.

“The world economy is simultaneously facing COVID-19, inflation, and policy uncertainty, with government spending and monetary policies in uncharted territory,” observes World Bank President David Malpass.

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

* Global economic growth will slow in 2022 vs. last year, World Bank predicts
* Fed Chair Powell tells Senators inflation is ‘severe threat’ to jobs
* Omicron may be peaking in the US and UK?
* US economy no longer needs aggressive stimulus, says Fed’s Powell
* Central banks are the main risk factor for global economy in 2022
* Russia keeps West guessing on Ukraine–and that’s the goal
* Debt-fueled spending is making a comeback for US consumers
* China inflation moderated in December
* Eurozone industrial output rose in November despite supply-chain bottlenecks
* US real yield for 10-year inflation-indexed Treasury rises to 9-month high:

Economists expect that US consumer inflation will continue to tick higher in tomorrow’s December report (scheduled for Wed., Jan. 12). Meanwhile, the Federal Reserve continues to offer increasingly hawkish commentary (on the margins) as the market prepares for one or more interest-rate hikes this year.

The Consumer Price Index (CPI) is expected to rise to a 7.1% for the year-over-year pace through December, according to Econoday.com’s consensus point forecast. That compares with a 6.8% increase previously. Core inflation (a more reliable measure of the trend) is lower, but the December print is also on track to edge higher, rising to 5.4%.

If the forecasts are right, pricing pressure will set yet another new multi-decade high at 2021’s close. Federal Reserve Chairman Jerome Powell says he’s on the job and will not let inflation become entrenched in the economy. The “transitory” view is long gone, but Powell is now offering a kind of feel-your-pain commiseration in public commentary.

“We know that high inflation exacts a toll, particularly for those less able to meet the higher costs of essentials like food, housing and transportation,” he said in prepared remarks released yesterday in advance of today’s testimony in Congress (Tues., Jan. 11). “We are strongly committed to achieving our statutory goals of maximum employment and price stability. We will use our tools to support the economy and a strong labor market and to prevent higher inflation from becoming entrenched.”

Perhaps, but Powell faces some tough questioning today, says Claudia Sahm, a former Fed economist who worked under Powell. “The Republicans are going to just grill him on inflation. Democrats — Sherrod Brown, Maxine Waters, the Squad — they’re totally going to take him to task on maximum employment. So he’s going to get it from both sides.”

Powell’s remarks suggest he’s going to attempt to tinker around the edge for thinking about policy. “We can begin to see that the post-pandemic economy is likely to be different in some respects,” he explains in the prepared speech. “The pursuit of our goals will need to take these differences into account. To that end, monetary policy must take a broad and forward-looking view, keeping pace with an ever-evolving economy.”

Will any of this make a difference or change perceptions of the Fed? Unclear, but we’re not holding our breath.

Meantime, what is clear is that recent forecasts that inflation is peaking have been wrong, so far, including efforts by CapitalSpectator.com. But we’re a glutton for punishment and our Inflation Trend Index (ITI) continues to indicate that pricing pressure has reached an apex, based on the median estimate for 13 indicators through this month (see this summary for details).

The caveat is that while the median estimate is looking relatively well behaved lately, the full range of estimates for January, for example, reminds that there’s (still) a strong case for remaining humble about projecting inflation’s path in the near term.

Of course, even if inflation is peaking, it’s not obvious that we’re about to return to a pre-pandemic level of inflation in the 2% range any time soon.

On the matter of monetary policy, one question that’s topical is whether the Fed’s recent shift to a more hawkish outlook will be curtailed by the potentially stronger economic headwinds linked to the spreading Omicron variant of the coronavirus? Not yet, or so Fed funds futures suggest. Although the implied probability of a rate hike for the upcoming at the Jan. 26 FOMC meeting is less than 10%, futures are pricing in a 76% probability for higher rates when the Fed meets on March 16, based on data published by CME Group.

And that may be merely the opening bid. Goldman Sachs, an investment bank, is now forecasting up to four rate hikes this year.

“The Fed’s growing discomfort with higher inflation is currently outweighing any concerns about downside risks from the Omicron variant,” advises Oxford Economics economists Nancy Vanden Houten and Kathy Bostjancic in a recent note to clients.

Let’s see if Powell strengthens or changes that narrative in today’s testimony to Congress.

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

* US Covid-19 cases surge to 1.35 million in a day, a new record
* Pfizer’s omicron vaccine will be ready in March, says CEO
* Fed Chair Powell pledges to control inflation
* Inflation cited as biggest problem since 1981, say small business owners
* Supply of government bonds set to swell in 2022
* N. Korea fires second test missile in six days, says S. Korea
* Bank stocks (KBE) continue to rise as outlook for higher interest rates resonates:

A negative tailwind blew through most of the major asset classes, in trading last week (through Friday, Jan. 7) via a set of proxy ETFs. The main exception: commodities, which rallied in the week just passed.

WisdomTree Commodity Index (GCC) increased 1.2% last week, lifting the ETF to a level that’s close to its highest price since late-November.

A factor that’s expected to support commodities prices is recovering Asian demand for oil, predicts Platts Analytics. “Apart from China with zero-COVID policy, most countries in the region are moving toward re-opening of economies despite seeing a rise in omicron cases,” says Lim Jit Yang, advisor for Asia-Pacific oil markets at the consultancy. “Any lockdowns are likely to be localized and more targeted, with less impact on oil demand than in the past.”

The head of commodities research at Goldman Sachs sees an extended bull market brewing for raw materials overall, in part due to shortages and a global economy flooded with liquidity. “The best place to be right now, particularly given the Fed pivot [to tighter monetary policy], are commodities,” says Jeff Currie. “We think you’re going to see another year of out-performance of commodities and real assets more broadly.”

The rest of the major asset classes fell last week. The biggest decline: a sharp reversal in previously high-flying US real estate investment trusts (REITs), a property proxy. Vanguard US Real Estate (VNQ) tumbled 4.3% last week, the first weekly decline for the ETF since the end of November.

Widespread losses weighed on the Global Market Index (GMI.F), an unmanaged benchmark (maintained by CapitalSpectator.com) that holds all the major asset classes (except cash) in market-value weights via ETF proxies. GMI.F lost 1.6% — the benchmark’s first weekly loss in the past three.

Despite the sharp setback in US REITs last week, Vanguard US Real Estate (VNQ) remains the leading performer by far for the major asset classes over the trailing one-year period. VNQ ended last week with a 37.5% total return – far above the rest of the field.

The biggest one-year loss for the major asset classes: foreign government bonds in developed markets. SPDR Bloomberg Barclays International Treasury Bond ETF (BWX) has shed 9.7% over the past 12 months.

Meanwhile, GMI.F ended last week with a strong 10.2% gain for the trailing one-year window.

Despite the latest wave of selling, most of the major asset classes continue to post relatively moderate drawdowns: no deeper than -10%.

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

* Russia warns of misunderstanding re: Ukraine ahead of talks with US
* Goldman Sach predicts four US rate hikes for 2022
* Key events to this week: inflation, interest rates and Fed testimony in Congress
* Emerging-market nations must prepare for US rate hikes, IMF advises
* Higher interest rates are boosting shares of bank stocks
* German 10-year yield poised to rise above zero for first time in 3 years
* US payrolls rose less than forecast in Dec but labor mkt near max employment
* US 10-year Treasury yield starts week at highest level in nearly two years:

● Financial Cold War: A View of Sino-US Relations from the Financial Markets
James A. Fok
Summary via publisher (Wiley)
Rising tensions between China and the United States have kept the financial markets on edge as a showdown between the world’s two largest economies seems inevitable. But what most people fail to recognise is the major impact that the financial markets themselves have had on the creation and acceleration of the conflict. In Financial Cold War: A View of Sino-US Relations from the Financial Markets, market structure and geopolitical finance expert James Fok explores the nuances of China-US relations from the perspective of the financial markets. The book helps readers understand how imbalances in the structure of global financial markets have singularly contributed to frictions between the two countries.

● Money Magic: An Economist’s Secrets to More Money, Less Risk, and a Better Life
Laurence Kotlikoff
Review via NextAvenue
Laurence Kotlikoff, the provocative Boston University economics professor and Social Security expert, has written an excellent new book, “Money Magic: An Economist’s Secrets to More Money, Less Risk, and a Better Life.” In it, he offers counterintuitive and surprising personal finance tips regardless of your age.
You’ll want to hear them.
I had to smile at some of what Kotlikoff expounds on because they’re often thought, but rarely verbalized.
Take this nugget: “Marrying for money may sound crass,” he writes. “But it’s one of the oldest financial practices. For most of us, love transcends money. But we humans have the capacity to fall in love with lots of people. And there’s no shame in targeting your swooning on someone who can provide you with a higher living standard. The bottom line: If you’re going shopping for a partner or a spouse, you might as well shop for someone who is earning a lot more than you.”

● Psychological Analysis: How to Make Money, Outsmart the Market, and Join the Smart Money Circle
Adam Sarhan
Summary via publisher (Wiley)
Conventional wisdom tells us that people are rational and make rational decisions with their money. But that’s simply not true considering most people fail to beat the market. Conventional wisdom also tells us that there are two primary ways to approach the market: technical and fundamental analysis. Again, that is not true because if it were—everyone would be rich. Think about it, how many times have you seen stocks with poor fundamentals go up, or stocks with great technicals go down? It’s obvious that something is missing. Author Adam Sarhan, Founder and CEO of 50 Park Investments, developed a new approach, titled, Psychological Analysis (PA). Coined by the author, the term teaches you how to make rational, not emotional, decisions with your money and shows you how to analyze both the individual and collective market mindset at a particular time based on the behavior and decision-making of people in the real-world. Psychological Analysis is designed to tip the odds of success in your favor.

● The Financial Crisis of 2008: A History of US Financial Markets 2000–2012
Barrie A. Wigmore
Summary via publisher (Cambridge U. Press)
Supported by ten years of research, Wigmore has gathered extensive data covering the 2008 financial crisis and subsequent recovery to provide the first comprehensive history of the period. Financial crises cannot occur unless institutional investors finance the bubbles that created them. Wigmore follows the trail of data putting pressure on institutional investors to achieve higher levels of returns that led to over-leverage throughout the financial system and placed such a burden on recovery. Here is a ‘very good picture – and painful reminder – of the crisis’ evolution across multiple asset classes, structures, participants, and geographies.’

● Risk Parity: How to Invest for All Market Environments
Alex Shahidi
Summary via publisher (Wiley)
The market volatility exacerbated by the COVID-19 pandemic has led many to question their exposure to risk in their own portfolios. But what should one do about it? In Risk Parity: How to Invest for All Market Environments, accomplished investment consultant Alex Shahidi delivers a powerful approach to portfolio management that reduces the potential for significant capital loss while maintaining an attractive expected return. The book focuses on allocating capital amongst four diverse asset classes: equities, commodities, Treasury bonds, and Treasury Inflation Protected Securities.

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The US 10-year Treasury yield rose to a nine-month high on Thursday (Jan. 6), which may be a prelude to setting a new pandemic high in the days ahead. If that happens, the increase would signal a higher probability that the benchmark rate would push above levels reached before the pandemic started in early 2020. During the 12 months prior to pandemic, the 10-year rate traded in the roughly 2%-3%-plus range.

The catalyst: higher inflation and the Federal Reserve’s growing hawkish bias on monetary policy on three fronts: scaling down and then ending its bond-buying program; reducing the central bank’s balance sheet; and raising interest rates.

Fed minutes released earlier this week reported that in the mid-December FOMC meeting: “Almost all participants agreed that it would likely be appropriate to initiate balance sheet runoff at some point after the first increase in the target range for the federal funds rate.”

“The fact that almost all participants agreed that it was appropriate to initiate the balance sheet runoff after the first increase in the target range for the fed funds rate implies that there’s not a big appetite for ‘let’s wait and see,’” says Kathy Jones, chief fixed income strategist at Charles Schwab. “Last time, they waited two years. This time, it looks like they’re ready to go.”

The Treasury market appears to be pricing in these factors. The 10-year yield rose for a fourth straight day on Thursday, reaching 1.73%, a nine-month high, based on daily data via Treasury.gov. That’s just below the previous high: 1.74% on March 31, 2021. A substantial and sustained rise above these levels would likely be viewed in markets as a signal that rates would continue to rise/remain elevated for the near term.

Fed funds futures are pricing in a roughly 92% probability that the central bank will leave its Fed funds target rate unchanged at a 0%-0.25% range in the upcoming Jan. 26 policy meeting. But the outlook shifts dramatically for the March FOMC announcement: futures estimate a 70%-plus probability for a rate hike on Mar. 16, according to CME Group data.

CapitalSpectator.com’s average fair-value estimat for the 10-year yield (based on three models) continues to reflect a moderate gap between the actual and modeled rate – a gap that continues to suggest an upside bias for the market rate.

Today’s December estimate marks the seventh straight month that the market-based 10-year yield traded below our fair value estimate. Last month’s negative 59-basis-point negative gap implies a flat to moderately higher 10-year rate for the near term.

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* Markets weigh possibility of three-facet Fed policy-tightening moves
* US 10yr Treasury yield briefly topped 1.75% on Thursday, a pandemic high
* Russia boosts influence in Kazakhstan amid political unrest
* Eurozone inflation ticked up to 5% in December, a new record high
* US jobless claims rose last week but remain near historic low
* US factory orders grew for a seventh-straight month in November
* US services sector growth slowed sharply in December via ISM survey data:

Forecasting is a necessary evil in investing. The very act of investing is an exercise in making assumption about future events. If you didn’t expect to book a profit, presumably you wouldn’t make the trade. The trouble starts when you move beyond this basic axiom and start making decisions about how to forecast, what to forecast, and over what time frame. But none of this changes the basic truism that risk is easier to forecast than return. There are caveats, of course, but even small relative advantages can be useful at times.

Yes, the details matter—a lot. For starters, risk comes in a rainbow of colors and so your preference for defining risk will cast a long shadow over your success (or not) in forecasting it. There are also limits related to how far ahead you can model risk. But beggars can’t be choosy and so we must use whatever edges the financial gods have given us.

But enough with generalizations. Let’s get specific. As a simple example, consider return volatility, a common if less-than-perfect proxy for risk. To be precise, let’s forecast the day-ahead return volatility for the stock market (S&P 500 Index) using a naïve model that simply uses the previous data point as the ex ante estimate. As the chart below indicates, this is a surprisingly reliable model. Indeed, the correlation between the current day’s risk and its one-day-ahead forecast is a bit more than 0.99, or just shy of perfect correlation, i.e., 1.0.

The accuracy of using recent history to forecast risk doesn’t translate to the return side of ledger. Indeed, even on a 1-day-forward basis, yesterday’s S&P 500 performance is essentially worthless as a predictor for today’s return. You might as well flip a coin. This simple fact shows up in the correlation of roughly zero for the two data points through time.

Similarly useless comparisons persist for longer-term comparisons. The lesson: return alone isn’t particularly helpful for predicting itself, at least not with a naïve model. To be fair, we can find more traction by looking for a mean-reversion factor, but that task is a higher level challenge vs. naive risk forecasting.

How far out you can push a simple risk forecast before it disintegrates? At ten days forward, there’s still a relatively high degree of correlation (roughly 0.85) between the current print and the ex ante estimate.

Going out to a 20-day forecast cuts the correlation to 0.64. We can see where this is going. There are limits to how far you can extend a naïve risk forecasting model into the future before the results turn into noise — and we reach those limits pretty quickly.

All of which inspires a series of questions: How far ahead is too far for developing useful risk forecasts? Does it vary for different asset classes? Can we enhance the reliability of risk-forecasting effort by using more sophisticated techniques to peer deeper into the future? And why is forecasting risk (or at least return volatility) easier than forecasting performance?

Great questions. In future updates to this series of articles I’ll take a stab at some answers and exploring some of the possibilities for building smarter risk models.

Learn To Use R For Portfolio Analysis
Quantitative Investment Portfolio Analytics In R:
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* Fed minutes suggest possible rate hike set for March
* Rising bond yields take a bite out of tech stocks
* Russia sends paratroopers into Kazakhstan on Thursday to suppress uprising
* North Korea says it successfully expands at strongest rate since July
* US economy slowed in December but ended 2021 with strong upside bias
* US company payrolls rose much faster than expected in Dec, ADP reports:

The Global Market Index’s risk-adjusted performance continued to roar higher through the end of 2021, based on the trailing 3-year Sharpe ratio, a measure of return adjusted by volatility. GMI started looking a bit subdued in November, thanks to widespread selling. But the strong rebound for risk assets in December fired up risk-adjusted results for GMI, an unmanaged, market-value-weighted portfolio that holds all the major asset classes (except cash).

GMI’s 3-year Sharpe ratio surged to 1.29 in December, the highest level in more than four years (black line in chart below). The slower moving trailing 10-year Sharpe ratio, by contrast, was relatively steady, inching up to 0.99 last month (red line), the highest since April 2019.

History suggests that upward spikes in GMI’s Sharpe ratio are quickly reversed, which implies that choppy market activity lies ahead. There’s no guarantee, of course. Indeed, skeptics of reading market history’s tea leaves for guidance are quick to note that much of what appeared reasonable for market activity in recent years has been trashed amid a mostly non-stop bull market.

Using drawdown to profile GMI’s risk certainly suggests a benign climate prevails. GMI closed at a record high 2021’s end, which translates to a zero peak-to-trough decline. That low-risk profile is in keeping with recent history: GMI’s drawdowns have been relatively mild for well over a year, ranging from zero to roughly -3.5% at most.

GMI represents a theoretical benchmark for the “optimal” portfolio. Using standard finance theory as a guide, this portfolio is considered a preferred strategy for the average investor with an infinite time horizon. Those assumptions are, of course, unrealistic in the real world. Nonetheless, GMI is useful as a baseline to begin research on asset allocation and portfolio design. GMI’s history suggests that this benchmark’s performance is competitive with active asset-allocation strategies overall, especially after adjusting for risk, trading costs and taxes.

For additional perspective, readers can use the risk profile for GMI alongside the current monthly updates on performance and expected return for the benchmark and its components. In addition, total return forecasts are updated monthly via three models at The ETF Portfolio Strategist.

The table below presents additional risk metrics for GMI and its underlying asset classes, based on a trailing 10-year window through last month.

Here are brief definitions of each risk metric:

Volatility: annualized standard deviation of monthly return

Sharpe ratio: ratio of monthly returns/monthly volatility (risk-free rate is assumed to be zero)

Sortino ratio: excess performance of downside semivariance (assuming 0% threshold target)

Ulcer Index: duration of drawdowns by selecting negative return for each period below the previous peak or high water mark

Maximum Drawdown: the deepest peak-to-trough decline

Beta: measure of volatility relative to a benchmark (in this case GMI)

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

* North Korea reportedly fires ballistic missile into the sea
* Protests in Kazakhstan intensify: government declares state of emergency
* Stock market ignores rising bond yields, for now
* Global manufacturing expansion continued at end of 2021
* Can US regain some of mfg output lost to foreigners? Companies aim to try
* Toyota tops GM for US car sales–first time foreign firm leads
* US home prices set to continue surging in 2022, Zillow predicts
* Job openings in US fell in Nov, but remained near record high
* Small-company wages up 4%-plus in December, a record high estimates Paychex
* US mfg activity slowed in Dec to 11-month low via ISM Mfg Index: