We are in a secular (long-term) bear market which started in 2000, and which could easily extend into the early 2020s. This is despite the fact that the S&P500 is 30% higher in 2016 than its highs in 2007 or 2000, which we believe has been artificially and entirely caused by Central Bank QE (Quantitative Easing) and does not reflect typical fundamentals behind any historical secular Bull markets.
There are four primary factors behind the secular bear market which has been characterized by a new normal of low global growth
Unprecedented and rapidly increasing levels of sovereign, corporate, and personal Debt
The rapid proliferation of technology and automation which is fundamentally deflationary
Very poor long-term demographic trends in the developed world (except the US) and in China
Continuing income normalization from globalization and the maturation of the outsourcing trend which limits wage growth in the West
The primary response to the growth slowdown has been monetary, i.e. QE (Quantitative Easing) and interest rates that have fallen below ZERO! This has successfully kept the deflationary tide at bay thus far, and has lifted Equity markets to record levels.
Global market volatility has increased significantly as the side-effects of these unconventional monetary policies (falling commodity prices and Emerging Market/China deflation) have made the markets much more fragile.
Volatility is expected to remain in the absence of economic growth, as the market swings from being pulled down by the deflationary secular bear market forces and being pushed up by the Central Bank support from QE and Negative Interest Rates, and fiscal stimulus expected from the new Trump Administration.
We believe we are (as of mid 2016)in the last quarter or so of the 7 year old rally from 2009. We believe this rally cycle will end with a fairly spectacular inflationary pop, and Fed will have no choice but to raise rates coincident with this last stretch of the rally cycle, as they have started to do.
A recession is inevitable in the next 2 to 3 years because of the debt overhang and this inflationary pop. Central Banks lose control when interest rate rises accelerate and inflation appears. A reversal of the globalization trend could be an additional catalyst. The weakest links in the sovereign and corporate debt chain can crack and trigger the recession, which could then create a knock-on effect on the dominoes of debt-encumbered Japan, the fragile Eurozone, and junk-rated commodity producers and corporations globally.
The new Trump administrations economic policies could potentially lighten the impact of this global recession on the US, making the recession longer but shallower than the 2008/2009 recession.
We do not expect the overall secular bear market to end until this recession ends, and until P/E ratios decline into the mid-single digits, as in other past secular bear markets.
Traditional fundamental oriented investment methods like Buy-and-Hold and Value Investing will fail or substantially under-perform relative to historical baselines, as well as in absolute terms, when measured over the remaining duration of the secular bear market. Read ourWhite Paper on the 4 Reasons why Buy-and-Hold could actually be harmful to your Portfolio.
Traditional diversification will fail or under-perform as a hedge against losses because of tighter correlation between asset classes during the intense deflationary periods of this global secular bear.
This is a traders market with formidable characteristics from both the 1930s and the 1970s, favoring trading-style strategies built on reliable approaches that integrate technical, macro, and fundamental analysis.
Learn more about the Four Pillars of our Absolute Return Solution
We see the financial markets as being structured, inter-related, driven by local and global macro-economics and fundamentals, and driven to extremes by the often emotional behavior of market participants.
On the other hand, we do not see the markets as being very efficient or random, i.e. we are convinced the Efficient Market Hypothesis and Random Walk and their applications are bankrupt ideas.
Our Absolute Return solution aims to expose these market structures,predict and identify market trends using the4 Pillarsbelow, and align investments dynamically to take advantage of opportunities that have the highest Reward-to-Risk profile. We have cut the teeth of these Pillars through real-time investment management since 2007, a period which covers two of the most significant Bear and Bull markets of the last 100 years.
We have developed an objective and adaptive Fractal Model that predicts market turning points or inflections, maturity of the current trends at different degrees, and the likely trajectory of future trends in all major financial and commodity markets. Some key breakthroughs we have made include the following
Underlying indicators that objectively reveal the fractal pattern inside the markets structure
Unique inter-market analysis that determines the structural correlation between major currency, bond, equity, and commodity markets
A comprehensive macro-economic overlay that aligns the global macro storyline with the fractal pattern and inter-market storyline, and which significantly increases forecast accuracy.
Pattern recognition to identify rhymingperiods with structurally similar price patterns at similar or different time-scales
We are also improving the algorithm with new market and macro data, i.e. evolving and refining the model as it learns from the market in real-time. This model and methodology has been back-tested to 1929, and has been used in real-time since 2007 to identify opportunities with the best reward-to-risk and determine the best entry/exit points in the context of managing real money.
The goal of our Macro analysis is to arrive at a coherent perspective and storyline which then acts as an overlay for our Fractal and Technical Analysis to help us determine the probability of potential scenarios.
The primary driver and storyline in Secular Bear markets has always been from Global Macro rather than from fundamental or cyclical performance of sectors and companies. We have seen ample evidence of this from the aftermath of the Internet crash in 2000-2002, the in-discriminate rise of the markets along with the US housing boom from 2003-2007, the Sub-Prime Crisis and its global aftermath in 2007-2009, and then the global Central Bank QE driven re-flationary boom since 2009 where the rising tide has risen all boats. Even the bull market since 2009 can be divided into distinct phases with different macro themes.
The magnitude, application, and location of QE and Central Bank intervention
QEs un-intended consequences on Commodity Prices and Emerging Markets
the aftermath of years of indiscriminate lending in China
Dropping Bond Yields including Negative Interest Rates and Carry Trades
The beginning of inflation fears and rapidly rising Yields, with the new Trump administration
We monitor key global macroeconomic indicators to identify the headwinds and tailwinds to major economies that are critical for global growth,and analyze to determine the relative importance and imminence of these factors.
We also have a widely cast net of News and Twitter feeds that brings in the perspective of some of the best minds in the industry that we use to ensure we have not missed anything of significance.
Two examples of original technical indicators we have developed to validate and improve the confidence and accuracy of our fractal forecasts are
1. A 2ndDerivative of Price model and methodology that forecasts (provides a pre-trigger signal) and then confirms trend changes in an assets price at multiple degrees of trend.
2. An important modification to the classic Support and Resistance level analysis, where a significance to the Support or Resistance level is assigned based on how it ties to the Fractal structure of the market. This helps project the probable shape and end of the current or forecasted trend in the asset or market being analyzed.
We also utilize top performing trend-following strategies which have proprietary tuning enhancement and are geared for the market environment at hand, and a composite fundamental/technical strategy incorporating Relative Strength in the Market Neutral portfolio. Our trend-following strategies are based on the proprietaryTrendFlexsystem developed by Baseline Analytics and captured in ourMarket Tourreview performed on the markets regularly.
Even if we maintain the right perspective to ascertain the markets direction, and use the best strategies to maximize the harvest from the trend, achieving the goal of consistent Absolute Return is impossible without objective and disciplined position and money management that controls the risk profile and equity draw-downs in the portfolio to meet the portfolio and client objectives. Our risk management approach is anchored in the four tenets of dynamically managing the 1) position size, 2) duration of the trade, 3) confidence (or probability) of the move, and 4) the asset class involved to maintain an optimum reward-to-risk ratio at the position level while controlling the draw-downs at a portfolio level. We also use data science approaches to study the historical performance of our strategies and adjust weights to achieve the desired portfolio performance.
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