Judging by the latest virus numbers in Europe, and government announcements to contain it, markets may soon have to read up on the math of lockdown economics. Before we get to that, though, investors have been locked in deep thought over the impact of the U.S. presidential elections, which seems to converge on trying to price in the consequences of a Biden victory and a “blue wave”. As I explained last week, investors seem to have concluded that this is good outcome for risk assets, though as I argued at the time, this isn’t entirely clear to me. To illuminate this further, it’s useful to consider how markets perceive a Blue wave in the context of the dollar and the U.S. bond market. As it turns out, the consensus position isn’t entirely clear, which is a hint. If markets can’t figure out how a Democratic sweep will impact the dollar and bonds, it’s difficult to have any view on how it would impact equities. The dollar is particularly interesting. It seems to me that analysts initially pinned recent weakness—effectively since April—on the inherent political risks associated with a Biden presidency, though it has since morphed into a bullish catalyst in the context of the expectation of surge in fiscal stimulus, funded by a benevolent and compliant Fed. Why this latter should necessarily be bearish for the dollar isn’t clear to me, especially not if it led to stronger growth in the U.S. compared to the rest of the world. By contrast, the idea, voiced in some corners of the market, that the U.S. is on its way to print away its exorbitant privilege—in effect losing its reserve currency status—seems even more ludicrous to me, even in world where China is now emerging as a potential adversary.
Read MoreIt’s fair to say that markets are now starting to pay some attention to the outcome of the U.S. presidential elections, and its potential implications for the price of key asset classes. As far the result goes, the incumbent Mr. Trump looks like a sitting duck. Mind you, that wouldn’t have been my position a month ago. I have been prejudiced towards the idea that a hapless Joe Biden and a “silent majority” in favor of Trump—or in opposition to the Democrats—would carry the president to a second term. Mr. Biden still seems hapless to me, and I suspect the silent voter is still on the president’s side. But neither of these tailwinds are likely to be enough to protect the incumbent from what is an increasingly disastrous performance in the face of the pandemic. Sure, we can argue that Trump has been dealt an unfortunate hand this year, but that’s the way the cookie crumbles. My predictions notwithstanding, the simple reason a Biden presidency is worth contemplating is because it is the outcome that markets are now entertaining. Recently, this view has been augmented with the taster in the form of the idea of a Democratic sweep of the Senate and the House. To the extent that it is possible to summarise markets’ assumptions about what a triumph for the Democrats will look like, it seems to be a relatively positive story, for now. Once Republicans have been put out to pasture, the counterproductive wrangling over the next stimulus bill will make way for a huge fiscal push in Q1, and the Fed will welcome such action with unlimited and soothing QE. As analysts from BoFA put it succinctly on Friday:
Read MoreIt’s been a while since I updated my views on markets, which invites humility. It usually takes a few weeks for me to get a feel for what’s really going on. I return to my analysis at a point when risk assets are on the back foot, the dollar is rallying, and bond yields are falling, though in all these cases, the moves are so far undramatic. Granted, a quick-fire 7% decline in Spoos since the end of August will have driven some Robinhood punters against the wall, but that’s hardly a surprise. Similarly, the dollar is not blowing the doors off more so than it has caught a stretched bearish position off guard. That, after all, is what currency markets do. Meanwhile in bonds; zzz. In preview; I think risk assets sell off further, the dollar has further upside, and as far as bond yields go, I think they will do more or less nothing. This is not a hill that I am willing to die on, though, One of the problems with trying to read the charts at the moment, is that base effects from the collapse during the initial phases of the Covid-19 shock are now coming into view. In other words, it’s very easy to convince yourself of the idea that the rally is running out of steam, simply by looking at trailing returns. The first chart on the next page shows that the six month stock-to-bond ratio on the S&P 500 has now made a full rebound from the collapse in March, forming a peak similar to after the rebound from the swoon in 2018, and after the initial snap-back following the selloff in early 2016. The data are inconclusive, but in any case un-troubling for investors.
Read MoreIt’s been a while since I updated these pages, mainly because I have recently moved across the country, back to the Big Smoke, where I am now nestling in the hopefully up-and-coming part of southern London. I will be up and running with my market updates and videos soon enough, but first things first. I have been sitting on this piece, mentally more than anything, for a while, and I thought it would be a nice way to re-start my posting. I have long been thinking about whether it is possible to provide a good quantitative argument in favor of the defunct value equities, or more specifically the value “factor”. I think it is, but as always, I leave to you to judge. In my last post before my temporary hiatus, I made the argument that the vast majority of investors are structurally short volatility. Accepting this premise raises the obvious question; how does one achieve a cheap and effective long vol position? In this post I will try to offer a concrete and quantitative perspective on this question using the simplest tools available to us from finance theory. Before I get to that, though, I want to state the problem more precisely. In a nutshell, the traditional 60/40 portfolio is doing too well. The increasingly concentrated leadership in equity beta centered around the ubiquitous growth factor—essentially U.S. technology firms—and the correlation of this position to the performance of government bonds—driven by structurally falling interest rates—has been a boon for investors. A 60/40 portfolio with a concentration in growth stocks has increased by a factor of almost 4 since 2010, beating the MSCI World by almost 25%, not to mention breezing past the main regional indices—MSCI EM and MSCI Europe—by a factor of 2-to-2.5. That’s great news, but it also puts investors in a bind. If a balanced portfolio is winning on both legs what happens when the tide turns?
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