Sunday, May 20, 2018

Deconstructing the institutional pain trade

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. The turnover rate of the trading model is high, and it has varied between 150% to 200% per month.

Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Bullish*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of the those email alerts is shown here.

Institutions and the pain trade
The BAML Fund Manager Survey (FMS) is one of the most interesting surveys around, as the frequency is regular (monthly), extensive, and it has a long history. For readers who are unfamiliar with the survey, it reflects mainly the views of fund managers with global investment mandates.

Reading between the lines of the latest FMS results, I found that institutional managers are positioned for a late cycle inflation surge, but they are starting to de-risk their portfolios in anticipation of weaker growth. To summarize, institutional managers believe that:
  • Growth momentum is slowing, but
  • Inflation expectations are rising, but
  • The day of reckoning, as defined by either a recession or even a yield curve inversion, is still a long way in the future.
Fund managers have positioned their portfolios:
  • In commodities, which I interpret as positioning for a late cycle inflation surge, but
  • They are de-risking by selling equities,
  • Selling their emerging market (EM) positions, and
  • Buying bonds, but
  • Portfolio risk appetite remains above average.
The highlights of the consensus portfolio bets amount to long energy, short USD, and short bonds. This analysis is highly speculative, but if I were the market gods and I wanted to inflict the maximum level of pain on market participants, here is what I would do.

The full post can be found at our new site here.

We would further like to announce our Sale in May. The offer is available only to the first 100 to sign up. Please use this link to order.

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