Financial markets directionality and Global Macro opportunities

Posted on 05. May, 2014 by Jean Jacques Ohana in Weekly Focus | Comments Off

Markets directionality may be defined as the propensity of financial assets to trend.

To compute this directionality on a dynamic basis, we first compose a basket comprising an equal number of stocks indices, commodities, currencies and bonds futures. We then calculate, on this set of markets, the average absolute Sharpe Ratios over a three-month horizon. We finally average this measure over a two-year rolling window to get our directionality indicator. This indicator, characterizing the average breadth of moves which realizes in global financial markets, is exhibited in figure 1.

The conclusion is very clear-cut. Markets have been without clear direction from 2010 onwards except when Central Banks lost control over the financial system in 2011. Interest rates have remained very low, equities have risen with a record low volatility while currencies have been stuck in very tight ranges. For example, the EUR/USD Fx rate was worth 1.34 at the end of 2010, 1.30 in 2011, 1.32 in 2012 and 1.38 in 2013. The German Bund 10 years rate have fluctuated between 1.20% and 2% since 2011. The Oil Brent was worth 108 USD at the end of 2011 and quotes 109 USD today. Emerging markets don’t move either. The Korean Kospi, for instance, which is representative of growth assets, has never exceeded a 15% amplitude since 2011.

Riskelia’s directionality indicator is strongly correlated to the rolling 2 years return of global CTAs as illustrated by their common historical path (figure 2). The correlation stands at 60% which is remarkable for an external and straightforward indicator inferred from an out of sample set of assets. Therefore, CTA and Global Macros rely upon directionality or breadth of assets moves to generate profits

As profit opportunities have been low over the last years, it is worth highlighting that major OECD economies have experienced a liquidity trap, i.e. an economic outlook where the natural real interest rates compatible with an economy running at full capacity should be highly negative (which is obviously unreachable in a situation of low inflation). In this context, the world faces global excess capacity, i.e. a situation of insufficient demand provoked by a lack of investment opportunities and a savings glut, a context which in turn perpetuates the low inflation/low rates environment. In this context, large budget deficits could have provided savings with a place to go, hence resolving the slack in the labor market and pushing up inflation. However, procyclical austerity policies implemented by OECD countries (in particular in Europe) have pushed Western economies deeper into the liquidity trap.

Tight fiscal policies have been compensated by exceptionally accommodative monetary policies from developed countries’ central banks. These combined policies have had several major impacts on financial markets:

  • First, medium term rates have been pushed significantly below nominal growth. As a matter of fact, nominal growth now exceeds five-years Government rates by 2% in all developed countries except the euro zone, pushing real rates well below historical standards. This financial repression is likely to last ten to twenty years to facilitate the western deleveraging. This has occurred several times in the past, like during the 1930’s in the US or between 1950 and 1970 in the UK. Hence, interest rates won’t realistically return to so-called “historical standards”: higher interest rates would come only with higher inflation or higher growth, which we don’t see coming given the synchronized austerity policies implemented in all countries except Japan and the important slack in the labor market. This environment of permanently low rates, associated with steep interest rate curves, will heavily penalize short bond investors as well as pension funds and insurance companies faced with a chronic asset/liability mismatch problem but will benefit to long bond investors “rolling down” the curve.
  • Second, risk premiums have realized in all types of assets except commodities and emerging assets. Equities have risen in developed countries, real estate prices have been supported, corporate bonds have been boosted by accommodative monetary policies while peripheral sovereign debts in the Eurozone have provided significant performance since the pledge of Mario Draghi to “do whatever it takes to save the euro”.

In this context, Riskelia recommends an alternative approach to global macro investment:

  1. Focus on assets providing a genuine risk premium. For example, the EUR/USD rate does not provide any premium and is manipulated by central banks. The natural trend is the appreciation (as highlighted by Riskelia here) but the ECB will strive to talk the EUR down each time it breaches levels of 1.39 USD.
  2. Balance the risks evenly across assets rising in various macro configurations: growth, inflation, deflation.
  3. Use a tactical layer (at Riskelia, we monitor trends, bubbles and global risk aversion) to prevent drawdowns and dynamically select the most rewarding assets.

Figure 1: Riskelia’s Directionality indicator on a diversified basket consisting of equities indices, commodities, currencies and bonds futures.


Figure 2: Riskelia’s Directionality indicator and Newedge CTA Index two-years rolling profit.

Figure 3: Difference between nominal growth (including inflation) and 5 years Government rate in major developed countries

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