global perspectives

    Opaque macro signals call for trend strategies in multi asset

    Opaque macro signals call for trend strategies in multi asset
    François Chareyron - Portfolio Manager

    François Chareyron

    Portfolio Manager
    Florian Ielpo - Head of Macro, Multi Asset

    Florian Ielpo

    Head of Macro, Multi Asset

    In the latest instalment of Simply put, we consider which alternative indicators investors should look to when macro signals lack clarity.   

      

    Need to know

    •    Macro data is failing to show any signs of the expected rapid economic slowdown at present, although some subcomponents of surveys hint at that outcome.
    •    When macro data lag, lessons from 2020 showed that trend-following strategies can yield essential insights about how to best adapt multi-asset portfolios to unseen risks.
    •    Comparing intraday and daily trend-following strategies highlights how these short- and medium-term indicators can help navigate uncertain times. 

     

    As detailed last week, economists and market observers continue to be surprised on the upside by recent macro data. In fairness, these positive surprises encompass both the ongoing strong growth momentum and increasingly gloomy forecasts. This raises two questions in investors’ minds. First, can we trust the macro data to accurately capture the expected downturn? And if not, where can we look to assess the risk of this downturn and get ready for it? In our view, we can probably trust the data but close monitoring of “below-the-surface” price action is required at this stage. Here is what we are currently observing for our latest macro views see our nowcasting update below).

    First, regarding the topic of macro data the world is facing a double cost shock: one concerning the cost of living (inflation) and another tied to the cost of funding (rising real rates). Notwithstanding the importance of the latter, the former is clearly an imminent threat to growth. Importantly, the Eurozone is more affected by rising energy prices – the most difficult part of this cost shock to evade – than other economic zones. The chain from an energy shock to a consumption slowdown is almost mechanical and currently weighs heaviest across Western Europe. So did we see any impact of this in European statistics in April? Headline numbers barely moved apart from the IFO. European Commission surveys cannot evade this outcome, but given their granularity, a more subtle analysis can be performed. As shown in Chart 1, the overall survey still towers its history at +0.5 standard deviations. However, looking at the details, all sectors are not showing the same resilience. Notably, across the nine subsectors of the survey, the consumer and retail trade components have respectively collapsed to -2 and -0.4 from 0 and -0.2 in February. What remains puzzling is that beyond these “mood driven” components, the service, employment and investment components are still rather strong. Under the surface of macro data, bad news can be found – that is a given – but the reported data remains solid for now. So what should we use to influence our portfolio positioning if we cannot trust the macro data?

     

     

    Chart 1. European Commission Survey Breakdowns: aggregated (left) and by sector (right)

    Multi-Asset-simply-put-EC survey-01.svg

    Source: Bloomberg, LOIM

     

    The most intuitive alternative solution is to look at market trends. Strategies that exploit the ebb and flow of market trends – trend-following strategies – can be a useful guide. Such strategies buy assets that gather investors’ attention while short selling the assets from which investors are fleeing. Two distinct types of strategies can be conceived by using two different types of information. One uses daily data, typically averaging performance across 12 months periods to generate trend-following themes – a typical medium-term investment pattern. Such strategies seek to exploit any persistent investor biases, which can be regarded as medium-term signals. The second type of trend-following strategy is one that has emerged more recently and focuses on intraday trends. When looking at intraday evolutions, systematic investors seek to buy or sell assets based on their intraday trading patterns. These strategies did rather well in 2020 but have struggled so far this year. Chart 2 compares their performance over four different periods: 2008, 2018, 2020 and 2022. Can we identify a pattern that could be exploited to answer the big question of whether investors are readying themselves for a recession?

     

     

    Chart 2. Representative evolution of intraday and daily cross asset trend-following strategies during four different years (2008, 2018, 2020, 2022)

    Multi-Asset-simply-put-Intraday evolution-01.svg

    Source: Bloomberg, LOIM.

     

    Firstly, during 2018 and 2020 the indexed performance of these strategies evolved in opposite directions. As the VIX complex erupted in 2018, medium-term investors were surprised by the shock while short-term investors were in a better position to adjust to this. The same happened in 2020, again at the expense of medium-term investors. In 2008, something different happened: the strength and pace of the fallout from Lehman Brothers’ collapse benefitted both types of strategy. What does this tell us about today? In our view, the current environment resembles the situation in 2008 more closely than either 2018 or 2020.  The latter were surprise “market stress” events while the pattern in 2008 reflected a more profound macro shock. The recent performance of both strategies (positive) is therefore yet another sign that the market is increasingly becoming prepared for a bearish event of an economic nature. So when macro data puts us in the dark, we have found that it makes more sense to remain nimble and adopt a “go-with-the-flow” approach.  This is more relevant as significant changes in macro trends have, historically, been well captured by a combination of both types of trend strategies. We do not think today is any different.

      Simply put, trend-following strategies are essential to help multi-asset portfolios adapt to risks that are otherwise difficult to observe.  

     


     

    Macro/nowcasting corner

    The most recent evolution of our proprietary nowcasting indicators for world growth, world inflation surprises and world monetary policy surprises are designed to keep track of the latest macro drivers making markets tick. Along with it, we wrap up the macro news of the week.

    The macro data published this week in both the US and the Eurozone once more delivers the message that growth remains strong. The inflation and cost shock is getting clearer however: the US ISM Price Paid component remains high as a token of this, while the Eurozone’s PPI reached 36%. Costs are progressing and is showing in the numbers released by corporates during this otherwise dull earnings season: among S&P500 constituents, sales have progressed by 14% while earnings only increased by 8%. The spread between the two shows the impact of rising costs on margins. 

    Beyond this cost element, growth-related indicators keep showing that US economic growth is slowing, although growth remains at an elevated pace. Non-farm payrolls have grown by 428k versus 380k expected. In two months, the US economy has been able to create nearly 1 million jobs, which historically would have taken 6 months (1999-2019 period). 70% of sectors have been creating jobs: given the “reopening trade” is well behind us, these jobs are new jobs created to meet strong demand. This demand also shows up in the high level of the US ISM. In truth, leading indicators such as the ISM point to slower economic activity, but their current level would have more than satisfied market observers three years ago. In the Eurozone, European Commission data also shows a deceleration, mirroring the evolution of retail sales. Finally, only China shows clear signs of a poor economic situation. The Service Caixin ISM posted a more rapid plunge than that of its industrial counterpart. This difference probably echoes the pandemic situation, which weighs more heavily on the service sector.

    Factoring in these new data points, our nowcasting indicators currently point to:

    • Worldwide growth remaining solid. The US and Eurozone still show solid numbers, while China remains set on a deteriorating path.
    • Inflation surprises should remain positive, but our signals have experienced a recent decline. A normalisation of inflation requires our indicator to go below the 50% line and we are not there yet.
    • Monetary policy is set to remain on the hawkish side, mirroring the strength of activity. The Fed has once more confirmed its hawkish stance – the ECB should be next.

     


    World growth nowcaster: long-term (left) and recent evolution (right)
    Multi-Asset-simply-put-Growth nowcaster-09May-01.svg

     

    World inflation nowcaster: long-term (left) and recent evolution (right)
    Multi-Asset-simply-put-Inflation nowcaster-09May-01.svg   
    World monetary policy nowcaster: long-term (left) and recent evolution (right)
    Multi-Asset-simply-put-Monetary Policy nowcaster-09May-01.svg

    Reading note: LOIM’s nowcasting indicator gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The Nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).

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