I am still in a quant-mood at the moment, so today I will go through some work I’ve done on portfolio optimization with US large cap equity sectors. I am doing this to augment my current MinVar framwork, which I use for my own investments. A quick re-cap on the basics of portfolio optimization, with advance apologies to PMs reading this and lamenting that I’ve missed something. Finance has two workhorse models; the tangent portfolio, which places the investor on the efficient frontier, where risk-adjusted return—or the Sharpe ratio—is maximised. Or the minimum variance portfolio, which offers exposure to the combination of assets with the lowest variance, or standard deviation, regardless of return. These portfolios often are estimated given a set of constraints, as I explain below. Assuming most portfolio allocation decisions start with one of these ideal models in mind—you either want to achieve the best risk adjusted return or the lowest volatility—the difference between the textbook models and real-time allocations is governed by the following layers of complexity.
Read MoreLast week, the leasehold and reform bill became law in the UK. This is not the end of leasehold reform. It is not even the beginning of the end. But it is, perhaps, the end of the beginning. This passage of the bill happened against the odds. It was crawling through parliament and when Rishi Sunak, somewhat unexpectedly, announced the general election on July the 4th, campaigners for leasehold reform—a group which yours truly have been loosely working with for a while—thought the bill would be lost. If you want to understand what happens to outstanding bills in the brief final sessions of parliament before prorogation, you need to read to up on something called wash-up. Put simply, it’s the period where outstanding bills are either rammed through as is, or kicked into the abyss never to be seen again. It is a borderline insane policy process, which breaks all the rules of legislation, simply to get the order book emptied as quickly as possible. The leasehold and reform bill made it, just, though without key additions such as a cap on ground rent or a ban on forfeiture. This is bitterly disappointing, especially in case of the former given that an agreement to cap ground rents to £250 pa was virtually agreed by the department and HMT, or so we’re told. But I guess we live to fight another day rather than having to start over.
Read MoreI’ve recently come back from a week on Ibiza—the smaller and cooler of the main Spanish Mediterranean isles—enjoying what has to be one of the most fantastic climates on earth. I come back to the realisation that I could have been more spendthrift in the pool bar despite its grotesquely overpriced drinks and snacks. Stocks are flying, credit spreads are narrow and volatility has plunged to a new low for the year. My relatively defensive portfolio is currently tracking a punchy 3.8% monthly gain for May, just shy of the 4.4% rise in the S&P 500. Long may it continue. I will have more to say about this in due course, but in the first instance, my recent work suggests that this rally has one strong tailwind on its side; the cyclical picture in the global economy has improved. My measures of global cyclical activity hit a new high at the end of Q1, and into Q2, from a trough last year, and cyclical equity returns are now re-accelerating, after softening a touch at the start of the year.
Read MoreI use three indicators in my work and analysis on the blog to describe the global business cycle; a weighted average of growth in global industrial production and trade, compiled by CPB, the global composite PMI, and a diffusion index of OECD’s leading indicators. Strictly speaking, the CPB data in this context are a coincident indicator, while the PMI and OECD LEIs are short-leading indicators. What’s the difference? At the moment the CPB data, updated through February, provide a guide of what happened at the start of 2024 and perhaps an early read on the Q1 GDP numbers, which have just started to trickle out. By contrast, the PMI and OECD LEIs are supposed to offer an early indication of what will happen in Q2. The distinctive lines between these definitions are fuzzy, so I tend to see these three as separate gauges of where global economic activity—with a weight towards developed markets—is right now.
But how do these indicators relate to the equity market? Let’s try to find out.
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