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John P. Cuthbert BA, MA, MSc,
JP Cuthbert Consulting Ltd,
Independent Financial Economist
The Market Timing Model:
2014 Outlook
Dec 2013
Regime Change? Or stuck in Transition ?
mailto:[email protected]:[email protected]:[email protected] -
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The Market Timing Model: 2014 Outlook
OVERVIEW: A YEAR THAT DEFIED THE PESSIMISTS
2012 was quite a year, but, wow, what a surprising year 2013 has been. And just howsurprising it has been can be seen if we briefly revisit investors main expectations in January.
The global consensus viewpoint began 2013 with global investors less optimistic about theoutlook for DMs and DM earnings than in 2012 (after all this is a low return environment, isntit?), equities were expected to be very volatile driven by policy and political machinations,few were less than very negative on the Euro-zone (and UK growth), many were more thanpositive on EM equities and EM Bonds, and whilst there had been some repositioning in Yieldplays (Credit in general, and HY in particular, was considered Overbought and set for littleupside), few emphasized anything like an acute short duration outlook in US Treasuries.
So how well did the consensus do?
In fact, in 2013, all these consensus calls proved to be wrong. Far from correcting, and in spiteof meagre earnings improvement, we witnessed one of the greatest years in US equitymultiple re-rating this century (according to Adam Parker at Morgan Stanley). DM equityvolatility collapsed, EM equities and EMBs vol soared as prices got pummeled, managingduration in fixed interest was key, credit was up (and some areas became very frothy), andEuropean growth got back into positive territory by H2. Japan aside, the play of the year wasperhaps Euro-zone Banks. In short, as one Morgan Stanley strategy note put it: it was a yearthat defied the pessimists.
Much of this failed to surprise this author (although the F eds early Taper talk and the extent
of the concomitant EM Crash were notable exceptions). In fact, we actually headlined our2013 prospectus as Risk-On: Transitioning to a more stable risk environment . The key to our2013 outlook was the combination of a fundamental shift to lower risk coupled with theeventual transition to better macro conditions. Both elements were not priced in December2012. A multiple re-rating was due!
Looking Ahead into 2014
Heading into 2014, this time round investors look more optimistic than pessimistic. This
optimism is well represented, I would argue , by BoAMLs global view that sees the USenvironment shifting from High Liquidity/Low Growth to High Growth/Low Liquidity orAbsolute Strategys view of regime Change . If BoAML are right, High Growth/Low Liquidity would indeed mark a substantial sea-change. And a sea-change that is well prefigured.
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There is also a considerable weight of sentiment behind Europe and Yen equities, but lessenthusiasm for Resources, Commodities (particularly Gold), and GEMs, though fund flowsappear to be recovering. Investors have also been exiting Sovereign Bonds , but not in GreatRotation volumes . Looking at these dispositions and how crowded they are, we continue tohold fast to the view that too many investors continue to misunderstand at least four things:
the underlying economic fundamentals; the scope and importance of policy and policyeffectiveness (most noticeably with regard to Fed Tapering); the dynamics of the commingledrelationship between underlying economic fundamentals and asset prices; and, finally, howthe key is not strategic certainty since this is not obtainable (the dynamics are just toointractable), but to trust to portfolio and tactical flexibility.
Indeed, as we have said so many times, so long as many investing voices persistentlycharacterize the current investment environment as one thing or another (Bull, Bear, NewNormal or take -off, and, for that matter as High Growth/Low Liquidity ), theres little roomfor the nuance of detail that we think is key to understanding market dynamics.
In short, although a year of DM growth acceleration, EM economic stabilization, andcontinued monetary policy accommodation looks as likely to us as it does to MorganStanleys 2014 Global Outlook, the translation into market effects is much more complicated.For our part, our Quantitative forecasts suggest that many of the key consensus trades areheading for considerable difficulty.
In our view, this difficulty is the natural consequence of two things: First, the valuationcompression of 2013; and second, the intractability of transitioning from an emergency policyenvironment to a standard mid cycle with MP normalization. Our view is that this is unlikely to be pulled off without policy error, that policy accommodation is and should be as much apart of fundamentals as earnings, so long as deleveraging is in place and deflationary risks
remain present.
Obviously, the US is to the forefront of such concerns, but in our view, both Japan and theEuro-Zone are equally notable tests as to whether our radical observation of emergencypolicy as part of the fundamentals fabric holds any water . We have no faith that Abenomicscan be truly made to work, or indeed that ultimately the Euro-zone can avoid a type ofdeflationary trap or Japanif ication, as MS call it. 2014 will tell us a great deal about thetractability of these deep concerns
We of course recognize in our Outlook for 2014 that regime change in US monetary policy,and the re-pricing of expectations about the sustainability of growth in China, the Emerging
Markets, Europe, and Japan will remain to the van, as they should. Our cavil is that marketviews and portfolio positioning on these concerns is misplaced.
Indeed our key ideas, in these regards (though note our forecast horizon is 6 months), followin bullet- point next
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The Market Timing Model: 2014 Outlook
Key strategic ideas for H1 2014;
Higher DM Growth yes, but NOT necessarily higher equities. The outlook remains very
dependent on the interaction between Fed Tapering (and its policy effects) and economicgrowth. But we think Fed Policy is flawed. The Fed first talked about Tapering, and nowhas acted, long before the type of economic conditions necessary for the Fed to act withclarity actually prevail. We are baffled by their observation that markets confusedtapering with tightening after Bernankes May comments . We beg to differ. We thinkthat the Fed has it the wrong way round!
For us, recent evidence from US Mortgage rates, mortgage REFI, and new housing starts,confirm that Tapering is Tightening! And Tightening means that the US economy will slow(curiously the Fed seems to agree, and lowered their 2014 growth expectations again..)
These curiosities in Fed decision-making, and their simultaneous insistence on datadependency (a flawed policy tractus if ever there was one) and forward guidance leavesmarkets trapped guessing simultaneously about the short run and the long-run. How doesthat help?
Ultimately, we think that a Yellen-led Fed is likely to shift the policy focus ontofundamental economic questions, such as the US economys long -run sustainable growthcapacity. This will be an added and unwanted complication. It will render it difficult formarkets to price forward guidance.
Moreover, we think that growth sustainability is unlikely. Indeed, the primarycharacteristic of the US cyclical expansion is not New Normal but Mini -Cycle. In otherwords, the US economy experiences sharp bursts of growth, followed by sharp slowdowns(as it has latterly with Q412 annualized GDP of 0.1% and Q313 at 3.6%), followed by a
further mini-cycle. In our view Tapering is tightening, and on our outlook the Fed will betapering/tightening through H1 2014 as the US economy slows sharply into its latest mini-cycle slowdown. Thats bad for risk assets..
Worst of all, Equities are not just no longer cheap, on our model the relationship with riskis statistically very stretched implying that risk/reward is as bad as it has been for sometime.
Indeed, one main model forecast is for a difficult period ahead for equities that involvesseveral sell-offs, and for global equities as a whole (in GBP terms) possibly no upside in H12014;
Our main Risk Model however suggests that risk overall will remain fairly subdued(implying the equity sell-offs will be modest, say -5% ), whilst subdued risk essentiallymeans that the longer-run remains positive for risk assets. From the forecast late springlows, our Models indicate a sharp rally for equities in particular;
But even though overall returns will be more subdued than 2013, because DM assetmarkets are trying to transition to mid-cycle type conditions, some sectors (Tech andIndustrials) will offer equity duration opportunities. In a limited credit environment,however, Mid-Cap and Small-Cap will remain more cyclically sensitive
Equally, because the impact of Fed Tapering is going to be more growth-negative thanmarkets expect, this has profound implications for both Sovereigns (a better but morerotational H1) and the USD (it s heading down, rather than up as the consensus expects).Whilst Gold and Global Emerging Markets are likely to benefit substantially on the other
side of a weakening USD trade;
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We do, of course, also recognize that policy certainty on US interest rate direction could(eventually) drastically change the US growth dynamic unleashing substantial pent updemand for capex and consumer spending. That would eventually boost growth andmarkets, though on our reckoning that would be a 2015 event at the earliest. In thisregard, for us the key is the behavior of US capital spending.
After all, what markets want (and CFOs too), and perhaps desperately need, is policycertainty. If they dont get that they will remain stuck in a transitional see -saw type ofenvironment.
Euro Growth will be topsy-turvy, but EPS will impress because of the extent of operationalleverage, particularly in the Banks
Japan equities are due a further tactical bounce, but for H1 as a whole they are going tobe a shocker as further stimulus gives way to Third Arrow policy uncertainty and a SalesTax shock induced growth slowdown.
China growth looks fragile to us, and the key is continued liquidity support from the PBOC.That said, in the longer-run, we see better growth stability if the shadow banking systemfades and the link between monetary policy and growth sustainability with it;
Commodities will be back as China, EM, and global growth stabilizes More EM growth/policy differentiation, but some surprisingly large winnersas the
emphasis shifts towards EMs that are growth dependent on DMs rather than the otherway round as it has been for so many years
In the following pages we look at each of these issues through the prism of our quantitativeforecast models.
These Models consist of several classes of proprietary methods, as follows:
Tactical mean-Reversion : This is the short-run model. It measures the performance trend as it
fluctuates around a selected moving average. The essential point is that the model has beenconstructed so as to create key thresholds (upper and lower limits) relative to the movingaverage of the underlying performance trend. These thresholds roughly correspond toOverbought and Oversold conditions, and so give investment signals.
Risk Forecast Model : The main risk model employs a stochastic technique to forecast therolling risk trend over a forward 6-month period.
Information Ratio Model : This is the long-run performance trend or forward curve model. Itemploys a special case moving average (called the Information Ratio), which we favourbecause, statistically, its properties tend to follow the commands of the Central Limit
Theorem (it is expressed in standard deviations). In other words, at standard deviation limits,the probability of mean-reversion or change in trend direction is extremely high.
Expected Return Model : Mean- reversion processes are path -dependent so we employ anindependent check on the possible performance path using an Expected Return engine thatgenerates weekly return forecasts over an 8-12 week horizon. It is based on the rsks/returnstochastic properties of the Mean -Reversion Tactical Model.
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WHATS BEEN HAPPENING TO MARKET DIRECTION?
Throughout the 2008-12 period of crisis, recovery and setback, equity and bond asset marketsexhibited strongly mean-reverting properties, where mean-reversion behaviour had beenhighly correlated with economic news-flow.
In the latter part of 2013 however, this behavior began to change.
Below we set out our main Tactical Mean-Reversion Model for Global Equities vs. GlobalSovereigns. The Mean-Reversion Model captures the short-run, week-to-week behavioraround the longer-run or moving average trend. This variation tends to have a repeatablesignature, and we have drawn in upper and lower bounds (consistent with Overbought andOversold thresholds) onto the chart to demonstrate their predictability (these thresholds arethemselves a function of the underlying risk and return interaction).
As can be seen, much of the mean-reversion behavior through 2010-early 2013 has respectedthese limits. But since the Fed began its Taper -talk in late May, the pricing behavior has beenmuch noisier, albeit less volatile (see area ringed within the yellow circle).
In our view, this statistical change in behavior reflects an attempt to transition to a differenttype of asset pricing environment . In this new regime, tail risk is at much lower levels (seechart overleaf), reflecting lower anxiety about structural problems, but markets are driftingbecause they are searching for more certainty on trend direction. And that direction isintimately related to Fed Policy, Interest Rates, and Duration.
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10
20
% a
c t i v e r e t u r n
FTSE World vs. Global Govt BondsTactical mean reversion drift model
superdetren
normal
normal lower
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Just how important tail risk is to this new environment can be seen in the following chart..
The risk model presented above is a substantial forecasting innovation, and the models
horizon is 6 months forward. Moreover, the model s signals have been powerful predictors ofnegative and positive total returns for equities and bonds, and it has not failed to predict onesignificant turn in trend risk direction in and out of sample since 1978. 2013 was a case inpoint.
Right now the signal from the Risk Model is long-run supportive for risk assets, ultimatelyimplying further gains for equities in particular.
However, the signal from the Global Equities vs. Global Sovereigns Risk Model shown abovehas been a little different from the signal for the pure Global Equities Model, indicating theimportance of the co-varying relationship with Bonds.
In the pure Global Equities Volatility Model, risk rose for awhile in 2013 and has only beencontracting since Bernankes Autumn clarifications. Looking into 2014, the Modelnonetheless predicts further amelioration in equity market risk conditions...
-2
3
8
13
18
23
28
33
38
43
48
T o
2 0
/ 1 2
/ 2 0 0 2
T o
0 7
/ 0 3
/ 2 0 0 3
T o
2 3
/ 0 5
/ 2 0 0 3
T o
0 8
/ 0 8
/ 2 0 0 3
T o
2 4
/ 1 0
/ 2 0 0 3
T o
0 9
/ 0 1
/ 2 0 0 4
T o
2 6
/ 0 3
/ 2 0 0 4
T o
1 1
/ 0 6
/ 2 0 0 4
T o
2 7
/ 0 8
/ 2 0 0 4
T o
1 2
/ 1 1
/ 2 0 0 4
T o
2 8
/ 0 1
/ 2 0 0 5
T o
1 5
/ 0 4
/ 2 0 0 5
T o
0 1
/ 0 7
/ 2 0 0 5
T o
1 6
/ 0 9
/ 2 0 0 5
T o
0 2
/ 1 2
/ 2 0 0 5
T o
1 7
/ 0 2
/ 2 0 0 6
T o
0 5
/ 0 5
/ 2 0 0 6
T o
2 1
/ 0 7
/ 2 0 0 6
T o
0 6
/ 1 0
/ 2 0 0 6
T o
2 2
/ 1 2
/ 2 0 0 6
T o
0 9
/ 0 3
/ 2 0 0 7
T o
2 5
/ 0 5
/ 2 0 0 7
T o
1 0
/ 0 8
/ 2 0 0 7
T o
2 6
/ 1 0
/ 2 0 0 7
T o
1 1
/ 0 1
/ 2 0 0 8
T o
2 8
/ 0 3
/ 2 0 0 8
T o
1 3
/ 0 6
/ 2 0 0 8
T o
2 9
/ 0 8
/ 2 0 0 8
T o
1 4
/ 1 1
/ 2 0 0 8
T o
3 0
/ 0 1
/ 2 0 0 9
T o
1 7
/ 0 4
/ 2 0 0 9
T o
3 / 0 7
/ 2 0 0 9
T o
1 8
/ 0 9
/ 2 0 0 9
T o
0 4
/ 1 2
/ 2 0 0 9
T o
1 9
/ 0 2
/ 2 0 1 0
T o
7 / 0 5
/ 2 0 1 0
T o
2 3
/ 0 7
/ 2 0 1 0
T o
8 / 1 0
/ 2 0 1 0
T o
2 4
/ 1 2
/ 2 0 1 0
T o
1 1
/ 3
/ 2 0 1 1
T o
2 7
/ 0 5
/ 2 0 1 1
T o
1 2
/ 0 8
/ 2 0 1 1
T o
2 8
/ 1 0
/ 2 0 1 1
T o
1 3
/ 0 1
/ 2 0 1 2
T o
3 0
/ 0 3
/ 2 0 1 2
T o
1 5
/ 0 6
/ 2 0 1 2
T o
3 1
/ 0 8
/ 2 0 1 2
T o 1 6
/ 1 1
/ 2 0 1 2
T o
1 / 2
/ 2 0 1 3
T o
1 9
/ 4
/ 2 0 1 3
T o
5 / 7
/ 2 0 1 3
T o
2 0
/ 9
/ 2 0 1 3
T o
6 / 1 2
/ 2 0 1 3
T o
3 1
/ 1
/ 2 0 1 4
T o
1 8
/ 4
/ 2 0 1 4
variance (rolling52W) actual
variance (rolling36W) forecast
Tail risk fell from ahighly elevated to acycle low and isstabilising at typicalmid-cycle levels
Global Equities vs.Global Govt Bondstail risk trend and riskforecast
forecast
trend
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TACTICAL CALL: SHORT-RUN BOUNCE FOR RISK ASSETS
Sadly, halcyon overall risk conditions do not necessarily imply a lower probability of sharpday-to-day equity sell-offs, but it does straightforwardly imply less mean-reversion.
And thats what we see in the Global Equities Mean-Reversion Tactical Model
As marked by the ringed circles, each of the last two equity market thrusts have topped outwell below the normal mean-reversion threshold. The model suggests, even if equityinvestors are becoming more bullish (actually Goldman Sachs report that the consensus hasbeen revising down expectations on US Growth from Q3 into Q4), they have been palpablyreluctant to seriously chase prices higher.
Under-pinning this behavior has been a modest correction in the Cyclical leaders (Industrials,
Tech), and a substantial correction in US Mid/Smaller Cap stocks (see overleaf). Thesynchronicity of many of these positions either at a BUY threshold (actually UK Mid-250 andUS Tech began to rally before the Feds taper call), suggests a broad based rally before thenext set back.
Tactically, the current mean-reversion level for Global Equities constitutes a substantial BUYsignal, but the preceding analysis suggests that Risk-On rallies will tend to be smaller inmagnitude (c. 4.5% in GBP terms from 13/12/13), but with real strength in Mid and Small Cap.
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0
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% a
c t i v e r e t u r n
FTSE World AA 52W MA :mean reversion drift
superdetren
Lower BUY threshold
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-8
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-2
0
2
4
T o
2 0
/ 1 2
/ 2 0 0 2
T o
1 4
/ 0 2
/ 2 0 0 3
T o
1 1
/ 0 4
/ 2 0 0 3
T o
0 6
/ 0 6
/ 2 0 0 3
T o
0 1
/ 0 8
/ 2 0 0 3
T o
2 6
/ 0 9
/ 2 0 0 3
T o
2 1
/ 1 1
/ 2 0 0 3
T o
1 6
/ 0 1
/ 2 0 0 4
T o
1 2
/ 0 3
/ 2 0 0 4
T o
0 7
/ 0 5
/ 2 0 0 4
T o
0 2
/ 0 7
/ 2 0 0 4
T o
2 7
/ 0 8
/ 2 0 0 4
T o
2 2
/ 1 0
/ 2 0 0 4
T o
1 7
/ 1 2
/ 2 0 0 4
T o
1 1
/ 0 2
/ 2 0 0 5
T o
0 8
/ 0 4
/ 2 0 0 5
T o
0 3
/ 0 6
/ 2 0 0 5
T o
2 9
/ 0 7
/ 2 0 0 5
T o
2 3
/ 0 9
/ 2 0 0 5
T o
1 8
/ 1 1
/ 2 0 0 5
T o
1 3
/ 0 1
/ 2 0 0 6
T o
1 0
/ 0 3
/ 2 0 0 6
T o
0 5
/ 0 5
/ 2 0 0 6
T o
3 0
/ 0 6
/ 2 0 0 6
T o
2 5
/ 0 8
/ 2 0 0 6
T o
2 0
/ 1 0
/ 2 0 0 6
T o
1 5
/ 1 2
/ 2 0 0 6
T o
0 9
/ 0 2
/ 2 0 0 7
T o
0 6
/ 0 4
/ 2 0 0 7
T o
0 1
/ 0 6
/ 2 0 0 7
T o
2 7
/ 0 7
/ 2 0 0 7
T o
2 1
/ 0 9
/ 2 0 0 7
T o
1 6
/ 1 1
/ 2 0 0 7
T o
1 1
/ 0 1
/ 2 0 0 8
T o
0 7
/ 0 3
/ 2 0 0 8
T o
0 2
/ 0 5
/ 2 0 0 8
T o
2 7
/ 0 6
/ 2 0 0 8
T o
2 2
/ 0 8
/ 2 0 0 8
T o
1 7
/ 1 0
/ 2 0 0 8
T o
1 2
/ 1 2
/ 2 0 0 8
T o
0 6
/ 0 2
/ 2 0 0 9
T o
0 3
/ 0 4
/ 2 0 0 9
T o
2 9
/ 0 5
/ 2 0 0 9
T o
2 4
/ 0 7
/ 2 0 0 9
T o
1 8
/ 0 9
/ 2 0 0 9
T o
1 3
/ 1 1
/ 2 0 0 9
T o
8 / 1
/ 2 0 1 0
T o
5 / 0 3
/ 2 0 1 0
T o
3 0
/ 0 4
/ 2 0 1 0
T o 2 5
/ 0 6
/ 2 0 1 0
T o
2 0
/ 0 8
/ 2 0 1 0
T o
1 5
/ 1 0
/ 2 0 1 0
T o
1 0
/ 1 2
/ 2 0 1 0
T o
4 / 2
/ 2 0 1 1
T o
1 / 4
/ 2 0 1 1
T o
2 7
/ 0 5
/ 2 0 1 1
T o
2 2
/ 0 7
/ 2 0 1 1
T o
1 6
/ 0 9
/ 2 0 1 1
T o
1 1
/ 1 1
/ 2 0 1 1
T o
0 6
/ 0 1
/ 2 0 1 2
T o
2 / 0 3
/ 2 0 1 2
T o
2 7
/ 0 4
/ 2 0 1 2
T o
2 2
/ 0 6
/ 2 0 1 2
T o
1 7
/ 0 7
/ 2 0 1 2
T o
1 2
/ 1 0
/ 2 0 1 2
T o
7 / 1 2
/ 2 0 1 2
T o
8 / 2
/ 2 0 1 3
T o
5 / 4
/ 2 0 1 3
T o
3 1
/ 5
/ 2 0 1 3
T o
2 6
/ 7
/ 2 0 1 3
T o
3 0
/ 8
/ 2 0 1 3
T o
1 5
/ 1 1
/ 2 0 1 3
% a c t i v e r e t u r n
Russell Mid-Cap vs Russell Large-Cap 52W MA :Tactical mean reversion drift (12W 2nd cycle)
superdetren
Normal upper
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0
5
T o
2 0
/ 1 2
/ 2 0 0 2
T o
1 4
/ 0 2
/ 2 0 0 3
T o
1 1
/ 0 4
/ 2 0 0 3
T o
0 6
/ 0 6
/ 2 0 0 3
T o
0 1
/ 0 8
/ 2 0 0 3
T o
2 6
/ 0 9
/ 2 0 0 3
T o
2 1
/ 1 1
/ 2 0 0 3
T o
1 6
/ 0 1
/ 2 0 0 4
T o
1 2
/ 0 3
/ 2 0 0 4
T o
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/ 0 5
/ 2 0 0 4
T o
0 2
/ 0 7
/ 2 0 0 4
T o
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/ 0 8
/ 2 0 0 4
T o
2 2
/ 1 0
/ 2 0 0 4
T o
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/ 1 2
/ 2 0 0 4
T o
1 1
/ 0 2
/ 2 0 0 5
T o
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/ 0 4
/ 2 0 0 5
T o
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/ 0 6
/ 2 0 0 5
T o
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/ 0 7
/ 2 0 0 5
T o
2 3
/ 0 9
/ 2 0 0 5
T o
1 8
/ 1 1
/ 2 0 0 5
T o
1 3
/ 0 1
/ 2 0 0 6
T o
1 0
/ 0 3
/ 2 0 0 6
T o
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/ 0 5
/ 2 0 0 6
T o
3 0
/ 0 6
/ 2 0 0 6
T o
2 5
/ 0 8
/ 2 0 0 6
T o
2 0
/ 1 0
/ 2 0 0 6
T o
1 5
/ 1 2
/ 2 0 0 6
T o
0 9
/ 0 2
/ 2 0 0 7
T o
0 6
/ 0 4
/ 2 0 0 7
T o
0 1
/ 0 6
/ 2 0 0 7
T o
2 7
/ 0 7
/ 2 0 0 7
T o
2 1
/ 0 9
/ 2 0 0 7
T o
1 6
/ 1 1
/ 2 0 0 7
T o
1 1
/ 0 1
/ 2 0 0 8
T o
0 7
/ 0 3
/ 2 0 0 8
T o
0 2
/ 0 5
/ 2 0 0 8
T o
2 7
/ 0 6
/ 2 0 0 8
T o
2 2
/ 0 8
/ 2 0 0 8
T o
1 7
/ 1 0
/ 2 0 0 8
T o
1 2
/ 1 2
/ 2 0 0 8
T o
0 6
/ 0 2
/ 2 0 0 9
T o
0 3
/ 0 4
/ 2 0 0 9
T o
2 9
/ 0 5
/ 2 0 0 9
T o
2 4
/ 0 7
/ 2 0 0 9
T o
1 8
/ 0 9
/ 2 0 0 9
T o
1 3
/ 1 1
/ 2 0 0 9
T o
8 / 1
/ 2 0 1 0
T o
5 / 0 3
/ 2 0 1 0
T o
3 0
/ 0 4
/ 2 0 1 0
T o 2 5
/ 0 6
/ 2 0 1 0
T o
2 0
/ 0 8
/ 2 0 1 0
T o
1 5
/ 1 0
/ 2 0 1 0
T o
1 0
/ 1 2
/ 2 0 1 0
T o
4 / 2
/ 2 0 1 1
T o
1 / 4
/ 2 0 1 1
T o
2 7
/ 0 5
/ 2 0 1 1
T o
2 2
/ 0 7
/ 2 0 1 1
T o
1 6
/ 0 9
/ 2 0 1 1
T o
1 1
/ 1 1
/ 2 0 1 1
T o
0 6
/ 0 1
/ 2 0 1 2
T o
2 / 0 3
/ 2 0 1 2
T o
2 7
/ 0 4
/ 2 0 1 2
T o
2 2
/ 0 6
/ 2 0 1 2
T o
1 7
/ 0 7
/ 2 0 1 2
T o
1 2
/ 1 0
/ 2 0 1 2
T o
7 / 1 2
/ 2 0 1 2
T o
2 / 2
/ 2 0 1 3
T o
2 9
/ 3
/ 2 0 1 3
T o
2 4
/ 5
/ 2 0 1 3
T o
1 9
/ 7
/ 2 0 1 3
T o
3 0
/ 8
/ 2 0 1 3
T o
0 8
/ 1 1
/ 2 0 1 3
% a
c t i v e r e t u r n
Russell 2000 vs S&P 500 52W MA :mean reversion drift (12W 2nd cycle)
superdetren
Normal u er
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The Market Timing Model: 2014 Outlook
THE 2014 OUTLOOK: EQUITY WEAKNESS/SELL-OFF
Sadly, the current equity, risk-on rally does not imply a further upside break-out in equityprices. Unfortunately, our long-run model suggests that it will be the last hurrah for awhile.That makes sense to us; many assets have been inflated by QE, and so Tapering is going to tellus which ones.
As the chart below makes clear, the current equity market trend is very stretched statistically(the relationship is shown in standard deviations), and, in the statistical model below therehave been no occasions in the last 10 years when equities did not correct from this highplaced statistical juncture (ringed in yellow). Mathematically, this is an easy read through; ifrisk is stable as we have seen, then a negative trend direction in our risk/return measureimplies return losses. In short the risk/reward ratio for Equities is poor.
In fact, in our performance trend or forward curve model above (it shows as the informationratio, a special case trend moving average), the red line is the predictive trend path forequities through to early June 2014 (which is generated by a unique proprietary process), andin the predicted trend there are several sell-offs and rallies.
This outlook is not quite consistent with some (e.g. Ned Davis or Marc Faber) who arepredicting a 16-20% sell-off for the S&P 500. Our best estimate from the model above is -5%in early January, and then some basing before a further sell-off, with equities essentially downuntil a spring March/April bottom followed by a sharp rally (see last spike in the chart).
-3
-2
-1
0
1
2
3
4
T o
2 0
/ 1 2
/ 2 0 0 2
T o
2 1
/ 0 3
/ 2 0 0 3
T o
2 0
/ 0 6
/ 2 0 0 3
T o
1 9
/ 0 9
/ 2 0 0 3
T o
1 9
/ 1 2
/ 2 0 0 3
T o
1 9
/ 0 3
/ 2 0 0 4
T o
1 8
/ 0 6
/ 2 0 0 4
T o
1 7
/ 0 9
/ 2 0 0 4
T o
1 7
/ 1 2
/ 2 0 0 4
T o
1 8
/ 0 3
/ 2 0 0 5
T o
1 7
/ 0 6
/ 2 0 0 5
T o
1 6
/ 0 9
/ 2 0 0 5
T o
1 6
/ 1 2
/ 2 0 0 5
T o
1 7
/ 0 3
/ 2 0 0 6
T o
1 6
/ 0 6
/ 2 0 0 6
T o
1 5
/ 0 9
/ 2 0 0 6
T o
1 5
/ 1 2
/ 2 0 0 6
T o
1 6
/ 0 3
/ 2 0 0 7
T o
1 5
/ 0 6
/ 2 0 0 7
T o
1 4
/ 0 9
/ 2 0 0 7
T o
1 4
/ 1 2
/ 2 0 0 7
T o
1 4
/ 0 3
/ 2 0 0 8
T o
1 3
/ 0 6
/ 2 0 0 8
T o
1 2
/ 0 9
/ 2 0 0 8
T o
1 2
/ 1 2
/ 2 0 0 8
T o
1 3
/ 0 3
/ 2 0 0 9
T o
1 2
/ 0 6
/ 2 0 0 9
T o
1 1
/ 0 9
/ 2 0 0 9
T o
1 1
/ 1 2
/ 2 0 0 9
T o
1 2
/ 0 3
/ 2 0 1 0
T o
1 1
/ 0 6
/ 2 0 1 0
T o
1 0
/ 9
/ 2 0 1 0
T o
1 0
/ 1 2
/ 2 0 1 0
T o
1 1
/ 3
/ 2 0 1 1
T o
1 0
/ 0 6
/ 2 0 1 1
T o
9 / 0 9
/ 2 0 1 1
T o
9 / 1 2
/ 2 0 1 1
T o
9 / 0 3
/ 2 0 1 2
T o
8 / 0 6
/ 2 0 1 2
T o
7 / 0 9
/ 2 0 1 2
T o
7 / 1 2
/ 2 0 1 2
T o
8 / 3
/ 2 0 1 3
T o
0 7
/ 6
/ 2 0 1 3
T o
3 0
/ 8
/ 2 0 1 3
T o
6 / 1 2
/ 2 0 1 3
T o
1 4
/ 2
/ 2 0 1 4
T o
1 6
/ 5
/ 2 0 1 4
s t a n
d a r d
d e v i a t i o n
s
FTSE World AA USDInformation Ratio & Forecast IR
IR (52W) IR (36W) projected
forecast
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8/13/2019 2013 Review & 2014 Outlook
11/21
11
EQUITY SELL-OFF DRIVER: TAPERING IS TIGHTENING
In our view, the Fed has misread the conclusions of the recent market response to the Maytapering talk.
It is hard not see to see Tapering as Tightening if it is data -dependent, and the recent effects ofhigher mortgage rates on refi and new housing starts tells us that there are palpable economiceffects associated with it too.
This analysis is confirmed by three yield asset groups as well as duration sensitive equities.
First, US 10 year Treasuries (i.e. duration sensitive) are tactically already heading down.
And on the 6 month longer-run outlook (IR Model overleaf) there is further to go before afloor is reached (probably at 3.2-3.3%). Some have argued that longer-dated Treasuriesalready price tapering. This may be true for the T30s, but we are conscious that the historicaverage premium between T30s and T10s has been 26bps, and with T30s at a 3.9% yield, thatsuggests that T10s (which are at 2.9%) are hugely vulnerable to substantial changes in growthand interest rate expectations.
But note that the tail of the longer-run forward curve (IR) model above for US T10s is up, andthat suggests to us that Tapering once again has discernible economic effects that induce theFed to backtrack in H1 , or at least for markets to price such an outcome
From the lows, US T10s could rally back to 3%, and as the IR trend line or forwardperformance curve in the chart overleaf approaches the zero return boundary horizon (as itdoes in the red forecast trend from the lows), the likelihood of positive returns fromTreasuries for H1 as a whole increases.
-10
-5
0
5
10
% a
c t i v e r e t u r n
US 10Yr Treasury USD 52W MA :mean reversion drift
superdetren
normal u er
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8/13/2019 2013 Review & 2014 Outlook
12/21
The Market Timing Model: 2014 Outlook
.
.. For now, US Dividend Aristocrats, which have been strong market out-performers, also lookset to take a hit before they too eventually can find a floor ..
-2
-1.5
-1
-0.5
0
0.5
1
1.5
2
2.5
3
T o
2 0
/ 1 2
/ 2
0 0 2
T o
1 4
/ 0 2
/ 2
0 0 3
T o
1 1
/ 0 4
/ 2
0 0 3
T o
0 6
/ 0 6
/ 2
0 0 3
T o
0 1
/ 0 8
/ 2
0 0 3
T o
2 6
/ 0 9
/ 2
0 0 3
T o
2 1
/ 1 1
/ 2
0 0 3
T o
1 6
/ 0 1
/ 2
0 0 4
T o
1 2
/ 0 3
/ 2
0 0 4
T o
0 7
/ 0 5
/ 2
0 0 4
T o
0 2
/ 0 7
/ 2
0 0 4
T o
2 7
/ 0 8
/ 2
0 0 4
T o
2 2
/ 1 0
/ 2
0 0 4
T o
1 7
/ 1 2
/ 2
0 0 4
T o
1 1
/ 0 2
/ 2
0 0 5
T o
0 8
/ 0 4
/ 2
0 0 5
T o
0 3
/ 0 6
/ 2
0 0 5
T o
2 9
/ 0 7
/ 2
0 0 5
T o
2 3
/ 0 9
/ 2
0 0 5
T o
1 8
/ 1 1
/ 2
0 0 5
T o
1 3
/ 0 1
/ 2
0 0 6
T o
1 0
/ 0 3
/ 2
0 0 6
T o
0 5
/ 0 5
/ 2
0 0 6
T o
3 0
/ 0 6
/ 2
0 0 6
T o
2 5
/ 0 8
/ 2
0 0 6
T o
2 0
/ 1 0
/ 2
0 0 6
T o
1 5
/ 1 2
/ 2
0 0 6
T o
0 9
/ 0 2
/ 2
0 0 7
T o
0 6
/ 0 4
/ 2
0 0 7
T o
0 1
/ 0 6
/ 2
0 0 7
T o
2 7
/ 0 7
/ 2
0 0 7
T o
2 1
/ 0 9
/ 2
0 0 7
T o
1 6
/ 1 1
/ 2
0 0 7
T o
1 1
/ 0 1
/ 2
0 0 8
T o
0 7
/ 0 3
/ 2
0 0 8
T o
0 2
/ 0 5
/ 2
0 0 8
T o
2 7
/ 0 6
/ 2
0 0 8
T o
2 2
/ 0 8
/ 2
0 0 8
T o
1 7
/ 1 0
/ 2
0 0 8
T o
1 2
/ 1 2
/ 2
0 0 8
T o
0 6
/ 0 2
/ 2
0 0 9
T o
0 3
/ 0 4
/ 2
0 0 9
T o
2 9
/ 0 5
/ 2 0 0 9
T o
2 4
/ 0 7
/ 2 0 0 9
T o
1 8
/ 0 9
/ 2 0 0 9
T o
1 3
/ 1 1
/ 2 0 0 9
T o
8 / 1
/ 2 0 1 0
T o
5 / 0 3
/ 2 0 1 0
T o
3 0
/ 0 4
/ 2
0 1 0
T o 2 5
/ 0 6
/ 2 0 1 0
T o
2 0
/ 0 8
/ 2
0 1 0
T o
1 5
/ 1 0
/ 2
0 1 0
T o
1 0
/ 1 2
/ 2
0 1 0
T o
4 / 2
/ 2 0 1 1
T o
1 / 4
/ 2 0 1 1
T o
2 7
/ 0 5
/ 2
0 1 1
T o
2 2
/ 0 7
/ 2
0 1 1
T o
1 6
/ 0 9
/ 2
0 1 1
T o
1 1
/ 1 1
/ 2
0 1 1
T o
0 6
/ 0 1
/ 2
0 1 2
T o
2 / 0 3
/ 2
0 1 2
T o
2 7
/ 0 4
/ 2
0 1 2
T o
2 2
/ 0 6
/ 2
0 1 2
T o
1 7
/ 0 7
/ 2
0 1 2
T o
1 2
/ 1 0
/ 2
0 1 2
T o
7 / 1 2
/ 2
0 1 2
T o
1 / 2
/ 2 0 1 3
T o
2 9
/ 3
/ 2 0 1 3
T o
2 4
/ 5
/ 2 0 1 3
T o
1 9
/ 7
/ 2 0 1 3
T o
3 0
/ 8
/ 2 0 1 4
T o
3 0
/ 8
/ 2 0 1 3
T o
3 / 1
/ 2 0 1 4
T o
7 / 2
/ 2 0 1 4
T o
4 / 4
/ 2 0 1 4
T o
3 0
/ 5
/ 2 0 1 4
s t a n
d a r d
d e v i a t i o n s
US 10Yr Treasury AA USDInformation Ratio & Forecast IR
IR (52W) IR (36W) projected
f orecast
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-3
-2
-1
0
1
2
3
T o
2 0
/ 1 2 / 2 0 0 2
T o
2 1
/ 0 3 / 2 0 0 3
T o
2 0
/ 0 6 / 2 0 0 3
T o
1 9
/ 0 9 / 2 0 0 3
T o
1 9
/ 1 2 / 2 0 0 3
T o
1 9
/ 0 3 / 2 0 0 4
T o
1 8
/ 0 6 / 2 0 0 4
T o
1 7
/ 0 9 / 2 0 0 4
T o
1 7
/ 1 2 / 2 0 0 4
T o
1 8
/ 0 3 / 2 0 0 5
T o
1 7
/ 0 6 / 2 0 0 5
T o
1 6
/ 0 9 / 2 0 0 5
T o
1 6
/ 1 2 / 2 0 0 5
T o
1 7
/ 0 3 / 2 0 0 6
T o
1 6
/ 0 6 / 2 0 0 6
T o
1 5
/ 0 9 / 2 0 0 6
T o
1 5
/ 1 2 / 2 0 0 6
T o
1 6
/ 0 3 / 2 0 0 7
T o
1 5
/ 0 6 / 2 0 0 7
T o
1 4
/ 0 9 / 2 0 0 7
T o
1 4
/ 1 2 / 2 0 0 7
T o
1 4
/ 0 3 / 2 0 0 8
T o
1 3
/ 0 6 / 2 0 0 8
T o
1 2
/ 0 9 / 2 0 0 8
T o
1 2
/ 1 2 / 2 0 0 8
T o
1 3
/ 0 3 / 2 0 0 9
T o
1 2
/ 0 6
/ 2 0 0 9
T o
1 1
/ 0 9
/ 2 0 0 9
T o
1 1
/ 1 2
/ 2 0 0 9
T o
1 2
/ 0 3
/ 2 0 1 0
T o
1 1
/ 0 6
/ 2 0 1 0
T o
1 0
/ 9 / 2 0 1 0
T o
1 0
/ 1 2 / 2 0 1 0
T o
1 1
/ 3
/ 2 0 1 1
T o
1 0
/ 0 6 / 2 0 1 1
T o
9 / 0 9 / 2 0 1 1
T o
9 / 1 2 / 2 0 1 1
T o
9 / 0 3 / 2 0 1 2
T o
8 / 0 6 / 2 0 1 2
T o
7 / 0 9 / 2 0 1 2
T o
7 / 1 2 / 2 0 1 2
T o
8 / 3
/ 2 0 1 3
T o
0 7
/ 6
/ 2 0 1 3
T o
3 0
/ 8
/ 2 0 1 3
T o
6 / 1 2 / 2 0 1 3
T o
1 4
/ 2
/ 2 0 1 4
T o
1 6
/ 5
/ 2 0 1 4
s t a n
d a r d
d e v i a t i o n s
S&P Hi-Yield Dividend Aristocrats vs. FTSE World USD Information Ratio & Forecast IR
IR (52W) IR (36W) projected
for ecast
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8/13/2019 2013 Review & 2014 Outlook
13/21
13
The third asset group that indicates that Tapering is Tightening is the forward forecast on USBanks.
Banks have been an enormous beneficiary from emergency monetary policy, but the trendforecast (which amounts to a considerable level of under-performance, perhaps in the order
of -20%), suggests that short rates do not remain anchored with obvious consequences fornet interest margins.
Of course, rises in short rates are hardly consistent with our mini-cycle slowdown thesis, soperhaps all that can be taken away here is significant surprise in US interest-rate expectationsgoing forward.
-3
-2
-1
0
1
2
3
T o
2 0
/ 1 2
/ 2 0 0 2
T o
2 1
/ 0 3
/ 2 0 0 3
T o
2 0
/ 0 6
/ 2 0 0 3
T o
1 9
/ 0 9
/ 2 0 0 3
T o
1 9
/ 1 2
/ 2 0 0 3
T o
1 9
/ 0 3
/ 2 0 0 4
T o
1 8
/ 0 6
/ 2 0 0 4
T o
1 7
/ 0 9
/ 2 0 0 4
T o
1 7
/ 1 2
/ 2 0 0 4
T o
1 8
/ 0 3
/ 2 0 0 5
T o
1 7
/ 0 6
/ 2 0 0 5
T o
1 6
/ 0 9
/ 2 0 0 5
T o
1 6
/ 1 2
/ 2 0 0 5
T o
1 7
/ 0 3
/ 2 0 0 6
T o
1 6
/ 0 6
/ 2 0 0 6
T o
1 5
/ 0 9
/ 2 0 0 6
T o
1 5
/ 1 2
/ 2 0 0 6
T o
1 6
/ 0 3
/ 2 0 0 7
T o
1 5
/ 0 6
/ 2 0 0 7
T o
1 4
/ 0 9
/ 2 0 0 7
T o
1 4
/ 1 2
/ 2 0 0 7
T o
1 4
/ 0 3
/ 2 0 0 8
T o
1 3
/ 0 6
/ 2 0 0 8
T o
1 2
/ 0 9
/ 2 0 0 8
T o
1 2
/ 1 2
/ 2 0 0 8
T o
1 3
/ 0 3
/ 2 0 0 9
T o
1 2
/ 0 6
/ 2 0 0 9
T o
1 1
/ 0 9
/ 2 0 0 9
T o
1 1
/ 1 2
/ 2 0 0 9
T o
1 2
/ 0 3
/ 2 0 1 0
T o
1 1
/ 0 6
/ 2 0 1 0
T o
1 0
/ 9
/ 2 0 1 0
T o
1 0
/ 1 2
/ 2 0 1 0
T o
1 1
/ 3
/ 2 0 1 1
T o
1 0
/ 0 6
/ 2 0 1 1
T o
9 / 0 9
/ 2 0 1 1
T o
9 / 1 2
/ 2 0 1 1
T o
9 / 0 3
/ 2 0 1 2
T o
8 / 0 6
/ 2 0 1 2
T o
7 / 0 9
/ 2 0 1 2
T o
7 / 1 2
/ 2 0 1 2
T o
8 / 3
/ 2 0 1 3
T o
0 7
/ 6
/ 2 0 1 3
T o
3 0
/ 8
/ 2 0 1 3
T o
6 / 1 2
/ 2 0 1 3
T o
1 4
/ 2
/ 2 0 1 4
T o
1 6
/ 5
/ 2 0 1 4
s t a n
d a r d
d e v i a t i o n s
US Banks vs. Global Govt Bonds USDInformation Ratio & Forecast IR
IR (52W) IR (36W) projected
forecast
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8/13/2019 2013 Review & 2014 Outlook
14/21
The Market Timing Model: 2014 Outlook
THE 2014 OUTLOOK: EQUITY DURATION PRICING
Other models also suggest that a fundamental sea-change in the asset pricing environment isunderway. The principal indicator is the behaviour of duration sensitive equities, that is, equitieswith a greater sensitivity to interest rate and growth/eps horizon expectations.
Most notably in the examples that follow, these asset classes are forecast to experience nobreakdown in their out-performance trend relative to the main equity index (or equivalent proxy)in spite of a sharp equity sell-off, although that does not imply that total returns will not benegative.
Primarily these are Tech and Capital Goods stocks, though, on our forward Models, ConsumerDiscretionary also fare well (as do Pharmas, albeit for other reasons). Interestingly, Global Autos
and Retailers do less well in 2014.
Global Industrials (see overleaf) also look well set as a relative out-performer, and althoughthis is not a class that is typically duration sensitive, the level of forecast out-performance inthe chart overleaf tells us a great deal about the rebound in global manufacturing, whichlooks set to strengthen into Q1 2014 consistent with Global manufacturing PMIs..
-3
-2
-1
0
1
2
3
T o
2 0
/ 1 2
/ 2 0 0 2
T o
2 1
/ 0 3
/ 2 0 0 3
T o
2 0
/ 0 6
/ 2 0 0 3
T o
1 9
/ 0 9
/ 2 0 0 3
T o
1 9
/ 1 2
/ 2 0 0 3
T o
1 9
/ 0 3
/ 2 0 0 4
T o
1 8
/ 0 6
/ 2 0 0 4
T o
1 7
/ 0 9
/ 2 0 0 4
T o
1 7
/ 1 2
/ 2 0 0 4
T o
1 8
/ 0 3
/ 2 0 0 5
T o
1 7
/ 0 6
/ 2 0 0 5
T o
1 6
/ 0 9
/ 2 0 0 5
T o
1 6
/ 1 2
/ 2 0 0 5
T o
1 7
/ 0 3
/ 2 0 0 6
T o
1 6
/ 0 6
/ 2 0 0 6
T o
1 5
/ 0 9
/ 2 0 0 6
T o
1 5
/ 1 2
/ 2 0 0 6
T o
1 6
/ 0 3
/ 2 0 0 7
T o
1 5
/ 0 6
/ 2 0 0 7
T o
1 4
/ 0 9
/ 2 0 0 7
T o
1 4
/ 1 2
/ 2 0 0 7
T o
1 4
/ 0 3
/ 2 0 0 8
T o
1 3
/ 0 6
/ 2 0 0 8
T o
1 2
/ 0 9
/ 2 0 0 8
T o
1 2
/ 1 2
/ 2 0 0 8
T o
1 3
/ 0 3
/ 2 0 0 9
T o
1 2
/ 0 6
/ 2 0 0 9
T o
1 1
/ 0 9
/ 2 0 0 9
T o
1 1
/ 1 2
/ 2 0 0 9
T o
1 2
/ 0 3
/ 2 0 1 0
T o
1 1
/ 0 6
/ 2 0 1 0
T o
1 0
/ 9
/ 2 0 1 0
T o
1 0
/ 1 2
/ 2 0 1 0
T o
1 1
/ 3
/ 2 0 1 1
T o
1 0
/ 0 6
/ 2 0 1 1
T o
9 / 0 9
/ 2 0 1 1
T o
9 / 1 2
/ 2 0 1 1
T o
9 / 0 3
/ 2 0 1 2
T o
8 / 0 6
/ 2 0 1 2
T o
7 / 0 9
/ 2 0 1 2
T o
7 / 1 2
/ 2 0 1 2
T o
8 / 3
/ 2 0 1 3
T o
0 7
/ 6
/ 2 0 1 3
T o
6 / 9
/ 2 0 1 3
T o
6 / 1 2
/ 2 0 1 3
T o
1 4
/ 2
/ 2 0 1 4
T o
1 6
/ 5
/ 2 0 1 4
s t a n
d a r d
d e v i a t i o n s
Nasdaq Composite (vs. S&P 500)52W IR & forecast IR
IR (52W) IR (36W) projected
forecast
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8/13/2019 2013 Review & 2014 Outlook
15/21
15
-3
-2
-1
0
1
2
3
4
T o
2 0
/ 1
2 / 2 0 0 2
T o
2 1
/ 0
3 / 2 0 0 3
T o
2 0
/ 0
6 / 2 0 0 3
T o
1 9
/ 0
9 / 2 0 0 3
T o
1 9
/ 1
2 / 2 0 0 3
T o
1 9
/ 0
3 / 2 0 0 4
T o
1 8
/ 0
6 / 2 0 0 4
T o
1 7
/ 0
9 / 2 0 0 4
T o
1 7
/ 1
2 / 2 0 0 4
T o
1 8
/ 0
3 / 2 0 0 5
T o
1 7
/ 0
6 / 2 0 0 5
T o
1 6
/ 0
9 / 2 0 0 5
T o
1 6
/ 1
2 / 2 0 0 5
T o
1 7
/ 0
3 / 2 0 0 6
T o
1 6
/ 0
6 / 2 0 0 6
T o
1 5
/ 0
9 / 2 0 0 6
T o
1 5
/ 1
2 / 2 0 0 6
T o
1 6
/ 0
3 / 2 0 0 7
T o
1 5
/ 0
6 / 2 0 0 7
T o
1 4
/ 0
9 / 2 0 0 7
T o
1 4
/ 1
2 / 2 0 0 7
T o
1 4
/ 0
3 / 2 0 0 8
T o
1 3
/ 0
6 / 2 0 0 8
T o
1 2
/ 0
9 / 2 0 0 8
T o
1 2
/ 1
2 / 2 0 0 8
T o
1 3
/ 0
3 / 2 0 0 9
T o
1 2
/ 0 6
/ 2 0 0 9
T o
1 1
/ 0 9
/ 2 0 0 9
T o
1 1
/ 1 2
/ 2 0 0 9
T o
1 2
/ 0 3
/ 2 0 1 0
T o
1 1
/ 0 6
/ 2 0 1 0
T o
1 0 /
9 / 2 0 1 0
T o
1 0
/ 1
2 / 2 0 1 0
T o
1 1
/ 3
/ 2 0 1 1
T o
1 0
/ 0
6 / 2 0 1 1
T o
9 / 0
9 / 2 0 1 1
T o
9 / 1
2 / 2 0 1 1
T o
9 / 0
3 / 2 0 1 2
T o
8 / 0
6 / 2 0 1 2
T o
7 / 0
9 / 2 0 1 2
T o
7 / 1
2 / 2 0 1 2
T o
8 / 3
/ 2 0 1 3
T o
0 7
/ 6
/ 2 0 1 3
T o
3 0
/ 8
/ 2 0 1 3
T o
6 / 1
2 / 2 0 1 3
T o
1 4
/ 2
/ 2 0 1 4
T o
1 6
/ 5
/ 2 0 1 4
IR (52W)
MSCI Industrials vs MSCI ConsumerStaples
information ratio trend & IR forecastforecast
trend
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8/13/2019 2013 Review & 2014 Outlook
16/21
The Market Timing Model: 2014 Outlook
THE 2014 OUTLOOK: EMS CONFIRM RE-PRICING
Another consensus position is to be underweight Emerging Markets equities, but here, onceagain, our forward models are suggesting something radically and surprisingly differentahead.
This is a curious forecast because it flies in the face of conventional reasoning. As the FedTapers, the USD should strengthen, and USD strength should be bad for EMs as it largely hasbeen since the Fed began its Taper -talk ..
There are perhaps other ways of explaining the signal, most notably that global growth provesto be stronger than domestic growth (thats exactly what global manufactur ing PMIs are
currently saying). Or perhaps it would be more obvious to confine the long-EM equity signalabove to curiosity or estimate error .
That is our concern too. But in actual fact, not only is the above signal measurably outside thebounds of estimates error, it is supported by the presence of the same signal in our modelsfor Copper, Korea equity, and Gold.
-2.5
-2
-1.5
-1
-0.5
0
0.5
1
1.5
2
T o
2 0
/ 1 2
/ 2 0 0 2
T o
2 1
/ 0 3
/ 2 0 0 3
T o
2 0
/ 0 6
/ 2 0 0 3
T o
1 9
/ 0 9
/ 2 0 0 3
T o
1 9
/ 1 2
/ 2 0 0 3
T o
1 9
/ 0 3
/ 2 0 0 4
T o
1 8
/ 0 6
/ 2 0 0 4
T o
1 7
/ 0 9
/ 2 0 0 4
T o
1 7
/ 1 2
/ 2 0 0 4
T o
1 8
/ 0 3
/ 2 0 0 5
T o
1 7
/ 0 6
/ 2 0 0 5
T o
1 6
/ 0 9
/ 2 0 0 5
T o
1 6
/ 1 2
/ 2 0 0 5
T o
1 7
/ 0 3
/ 2 0 0 6
T o
1 6
/ 0 6
/ 2 0 0 6
T o
1 5
/ 0 9
/ 2 0 0 6
T o
1 5
/ 1 2
/ 2 0 0 6
T o
1 6
/ 0 3
/ 2 0 0 7
T o
1 5
/ 0 6
/ 2 0 0 7
T o
1 4
/ 0 9
/ 2 0 0 7
T o
1 4
/ 1 2
/ 2 0 0 7
T o
1 4
/ 0 3
/ 2 0 0 8
T o
1 3
/ 0 6
/ 2 0 0 8
T o
1 2
/ 0 9
/ 2 0 0 8
T o
1 2
/ 1 2
/ 2 0 0 8
T o
1 3
/ 0 3
/ 2 0 0 9
T o
1 2
/ 0 6
/ 2 0 0 9
T o
1 1
/ 0 9
/ 2 0 0 9
T o
1 1
/ 1 2
/ 2 0 0 9
T o
1 2
/ 0 3
/ 2 0 1 0
T o
1 1
/ 0 6
/ 2 0 1 0
T o
1 0
/ 9
/ 2 0 1 0
T o
1 0
/ 1 2
/ 2 0 1 0
T o
1 1
/ 3
/ 2 0 1 1
T o
1 0
/ 0 6
/ 2 0 1 1
T o
9 / 0 9
/ 2 0 1 1
T o
9 / 1 2
/ 2 0 1 1
T o
9 / 0 3
/ 2 0 1 2
T o
8 / 0 6
/ 2 0 1 2
T o
7 / 0 9
/ 2 0 1 2
T o
7 / 1 2
/ 2 0 1 2
T o
8 / 3
/ 2 0 1 3
T o
0 7
/ 6
/ 2 0 1 3
T o
3 0
/ 8
/ 2 0 1 3
T o
6 / 1 2
/ 2 0 1 3
T o
1 4
/ 2
/ 2 0 1 4
T o
1 6
/ 5
/ 2 0 1 4
% s
t a n
d a r d
d e v i a t i o n
MSCI EMs vs. DMs USD 52W IR & IR forecast trend
IR (52W) IR (36W) projected
EMs are bounceingfrom a post-Lehman
Bros type low
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8/13/2019 2013 Review & 2014 Outlook
17/21
17
...
-4
-3
-2
-1
0
1
2
3
4
T
o 2
0 / 1 2
/ 2 0 0 2
T
o 2
1 / 0 3
/ 2 0 0 3
T
o 2
0 / 0 6
/ 2 0 0 3
T
o 1
9 / 0 9
/ 2 0 0 3
T
o 1
9 / 1 2
/ 2 0 0 3
T
o 1
9 / 0 3
/ 2 0 0 4
T
o 1
8 / 0 6
/ 2 0 0 4
T
o 1
7 / 0 9
/ 2 0 0 4
T
o 1
7 / 1 2
/ 2 0 0 4
T
o 1
8 / 0 3
/ 2 0 0 5
T
o 1
7 / 0 6
/ 2 0 0 5
T
o 1
6 / 0 9
/ 2 0 0 5
T
o 1
6 / 1 2
/ 2 0 0 5
T
o 1
7 / 0 3
/ 2 0 0 6
T
o 1
6 / 0 6
/ 2 0 0 6
T
o 1
5 / 0 9
/ 2 0 0 6
T
o 1
5 / 1 2
/ 2 0 0 6
T
o 1
6 / 0 3
/ 2 0 0 7
T
o 1
5 / 0 6
/ 2 0 0 7
T
o 1
4 / 0 9
/ 2 0 0 7
T
o 1
4 / 1 2
/ 2 0 0 7
T
o 1
4 / 0 3
/ 2 0 0 8
T
o 1
3 / 0 6
/ 2 0 0 8
T
o 1
2 / 0 9
/ 2 0 0 8
T
o 1
2 / 1 2
/ 2 0 0 8
T
o 1
3 / 0 3
/ 2 0 0 9
T o
1 2
/ 0 6
/ 2 0 0 9
T o
1 1
/ 0 9
/ 2 0 0 9
T o
1 1
/ 1 2
/ 2 0 0 9
T o
1 2
/ 0 3
/ 2 0 1 0
T o
1 1
/ 0 6
/ 2 0 1 0
T o
1 0
/ 9
/ 2 0 1 0
T
o 1
0 / 1 2
/ 2 0 1 0
T o
1 1
/ 3
/ 2 0 1 1
T
o 1
0 / 0 6
/ 2 0 1 1
T o
9 / 0 9
/ 2 0 1 1
T o
9 / 1 2
/ 2 0 1 1
T o
9 / 0 3
/ 2 0 1 2
T o
8 / 0 6
/ 2 0 1 2
T o
7 / 0 9
/ 2 0 1 2
T o
7 / 1 2
/ 2 0 1 2
T o
8 / 3
/ 2 0 1 3
T o
0 7
/ 6
/ 2 0 1 3
T o
3 0
/ 8
/ 2 0 1 3
T o
6 / 1 2
/ 2 0 1 3
T o
1 4
/ 2
/ 2 0 1 4
T o
1 6
/ 5
/ 2 0 1 4
% s
t a n
d a r d
d e v i a t i o n
DJ Copper vs FTSE World USD52W IR & IR forecast trend
IR (52W) IR (36W) projected
-2
-1.5
-1
-0.5
0
0.5
1
1.5
2
2.5
T o
2 0
/ 1 2
/ 2 0 0 2
T o
2 1
/ 0 3
/ 2 0 0 3
T o
2 0
/ 0 6
/ 2 0 0 3
T o
1 9
/ 0 9
/ 2 0 0 3
T o
1 9
/ 1 2
/ 2 0 0 3
T o
1 9
/ 0 3
/ 2 0 0 4
T o
1 8
/ 0 6
/ 2 0 0 4
T o
1 7
/ 0 9
/ 2 0 0 4
T o
1 7
/ 1 2
/ 2 0 0 4
T o
1 8
/ 0 3
/ 2 0 0 5
T o
1 7
/ 0 6
/ 2 0 0 5
T o
1 6
/ 0 9
/ 2 0 0 5
T o
1 6
/ 1 2
/ 2 0 0 5
T o
1 7
/ 0 3
/ 2 0 0 6
T o
1 6
/ 0 6
/ 2 0 0 6
T o
1 5
/ 0 9
/ 2 0 0 6
T o
1 5
/ 1 2
/ 2 0 0 6
T o
1 6
/ 0 3
/ 2 0 0 7
T o
1 5
/ 0 6
/ 2 0 0 7
T o
1 4
/ 0 9
/ 2 0 0 7
T o
1 4
/ 1 2
/ 2 0 0 7
T o
1 4
/ 0 3
/ 2 0 0 8
T o
1 3
/ 0 6
/ 2 0 0 8
T o
1 2
/ 0 9
/ 2 0 0 8
T o
1 2
/ 1 2
/ 2 0 0 8
T o
1 3
/ 0 3
/ 2 0 0 9
T o
1 2
/ 0 6
/ 2 0 0 9
T o
1 1
/ 0 9
/ 2 0 0 9
T o
1 1
/ 1 2
/ 2 0 0 9
T o
1 2
/ 0 3
/ 2 0 1 0
T o
1 1
/ 0 6
/ 2 0 1 0
T o
1 0
/ 9
/ 2 0 1 0
T o
1 0
/ 1 2
/ 2 0 1 0
T o
1 1
/ 3
/ 2 0 1 1
T o
1 0
/ 0 6
/ 2 0 1 1
T o
9 / 0 9
/ 2 0 1 1
T o
9 / 1 2
/ 2 0 1 1
T o
9 / 0 3
/ 2 0 1 2
T o
8 / 0 6
/ 2 0 1 2
T o
7 / 0 9
/ 2 0 1 2
T o
7 / 1 2
/ 2 0 1 2
T o
8 / 3
/ 2 0 1 3
T o
0 7
/ 6
/ 2 0 1 3
T o
3 0
/ 8
/ 2 0 1 3
T o
6 / 1 2
/ 2 0 1 3
T o
1 4
/ 2
/ 2 0 1 4
T o
1 6
/ 5
/ 2 0 1 4
% s
t a n
d a r d
d e v i a t i o n
MSCI Korea vs FTSE World USD 52W IR & IR forecast trend
IR (52W) IR (36W) projected
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8/13/2019 2013 Review & 2014 Outlook
18/21
The Market Timing Model: 2014 Outlook
THE USD OUTLOOK
As we have remarked, all of this is somewhat curious. But perhaps the best indicator of whatis going on is the forward curve performance signal from Gold (see below).
Now, of course, Golds behavior is itself more than a little curious (although we have been arecent bear because of rising real interest rate expectations), but one thing we know is thatGolds relationship with the USD is a good example of a numeraire effect. Since Gold is largelypriced in Dollars and devaluation in the USD is straightforwardly a re-valuation in Gold (orindeed anything else priced in USD, like Copper), then the primary explanation for the positive
Gold signal above is a reversal in the US Dollars performance direction.
So whats our take on the USD?
Wait for it
-4
-3
-2
-1
0
1
2
3
T o
2 0
/ 1 2
/ 2 0 0 2
T o
2 1
/ 0 3
/ 2 0 0 3
T o
2 0
/ 0 6
/ 2 0 0 3
T o
1 9
/ 0 9
/ 2 0 0 3
T o
1 9
/ 1 2
/ 2 0 0 3
T o
1 9
/ 0 3
/ 2 0 0 4
T o
1 8
/ 0 6
/ 2 0 0 4
T o
1 7
/ 0 9
/ 2 0 0 4
T o
1 7
/ 1 2
/ 2 0 0 4
T o
1 8
/ 0 3
/ 2 0 0 5
T o
1 7
/ 0 6
/ 2 0 0 5
T o
1 6
/ 0 9
/ 2 0 0 5
T o
1 6
/ 1 2
/ 2 0 0 5
T o
1 7
/ 0 3
/ 2 0 0 6
T o
1 6
/ 0 6
/ 2 0 0 6
T o
1 5
/ 0 9
/ 2 0 0 6
T o
1 5
/ 1 2
/ 2 0 0 6
T o
1 6
/ 0 3
/ 2 0 0 7
T o
1 5
/ 0 6
/ 2 0 0 7
T o
1 4
/ 0 9
/ 2 0 0 7
T o
1 4
/ 1 2
/ 2 0 0 7
T o
1 4
/ 0 3
/ 2 0 0 8
T o
1 3
/ 0 6
/ 2 0 0 8
T o
1 2
/ 0 9
/ 2 0 0 8
T o
1 2
/ 1 2
/ 2 0 0 8
T o
1 3
/ 0 3
/ 2 0 0 9
T o
1 2
/ 0 6
/ 2 0 0 9
T o
1 1
/ 0 9
/ 2 0 0 9
T o
1 1
/ 1 2
/ 2 0 0 9
T o
1 2
/ 0 3
/ 2 0 1 0
T o
1 1
/ 0 6
/ 2 0 1 0
T o
1 0
/ 9
/ 2 0 1 0
T o
1 0
/ 1 2
/ 2 0 1 0
T o
1 1
/ 3
/ 2 0 1 1
T o
1 0
/ 0 6
/ 2 0 1 1
T o
9 / 0 9
/ 2 0 1 1
T o
9 / 1 2
/ 2 0 1 1
T o
9 / 0 3
/ 2 0 1 2
T o
8 / 0 6
/ 2 0 1 2
T o
7 / 0 9
/ 2 0 1 2
T o
7 / 1 2
/ 2 0 1 2
T o
8 / 3
/ 2 0 1 3
T o
0 7
/ 6
/ 2 0 1 3
T o
3 0
/ 8
/ 2 0 1 3
T o
6 / 1 2
/ 2 0 1 3
T o
1 4
/ 2
/ 2 0 1 4
T o
1 6
/ 5
/ 2 0 1 4
% s
t a n
d a r d
d e v i a t i o n
DJ Gold vs Global Equities 52W IR & IR forecast trend USD
IR (52W) IR (36W) projected
Normal upper
normal low er level
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8/13/2019 2013 Review & 2014 Outlook
19/21
-
8/13/2019 2013 Review & 2014 Outlook
20/21
The Market Timing Model: 2014 Outlook
ONE FINAL THOUGHT: JAPAN
In 2013 Japan Equities have been a fascinating place to be. A radical reversal in BOJ policy, areformist new Prime Minister, and a sharply higher equity market are some of the keyhighlights. But our forward performance curve trend Model indicates this is about to besharply challenged.
In the Model below, Japan equities are as statistically stretched (relative to Global Equities) asthey have been at any point in the last 15 years. The last time they were this Overbought(early 2006), they under-performed by -17% relative.
On our shorter-run horizon model they have some scope of a rally, but coupled with ourJPY/USD model (which also points to a sharp correction), something like the 2006 sell-off sorder of magnitude is likely this time round too.
-3
-2
-1
0
1
2
3
4
T o
2 0
/ 1 2
/ 2 0 0 2
T o
2 1
/ 0 3
/ 2 0 0 3
T o
2 0
/ 0 6
/ 2 0 0 3
T o
1 9
/ 0 9
/ 2 0 0 3
T o
1 9
/ 1 2
/ 2 0 0 3
T o
1 9
/ 0 3
/ 2 0 0 4
T o
1 8
/ 0 6
/ 2 0 0 4
T o
1 7
/ 0 9
/ 2 0 0 4
T o
1 7
/ 1 2
/ 2 0 0 4
T o
1 8
/ 0 3
/ 2 0 0 5
T o
1 7
/ 0 6
/ 2 0 0 5
T o
1 6
/ 0 9
/ 2 0 0 5
T o
1 6
/ 1 2
/ 2 0 0 5
T o
1 7
/ 0 3
/ 2 0 0 6
T o
1 6
/ 0 6
/ 2 0 0 6
T o
1 5
/ 0 9
/ 2 0 0 6
T o
1 5
/ 1 2
/ 2 0 0 6
T o
1 6
/ 0 3
/ 2 0 0 7
T o
1 5
/ 0 6
/ 2 0 0 7
T o
1 4
/ 0 9
/ 2 0 0 7
T o
1 4
/ 1 2
/ 2 0 0 7
T o
1 4
/ 0 3
/ 2 0 0 8
T o
1 3
/ 0 6
/ 2 0 0 8
T o
1 2
/ 0 9
/ 2 0 0 8
T o
1 2
/ 1 2
/ 2 0 0 8
T o
1 3
/ 0 3
/ 2 0 0 9
T o
1 2
/ 0 6
/ 2 0 0 9
T o
1 1
/ 0 9
/ 2 0 0 9
T o
1 1
/ 1 2
/ 2 0 0 9
T o
1 2
/ 0 3
/ 2 0 1 0
T o
1 1
/ 0 6
/ 2 0 1 0
T o
1 0
/ 9
/ 2 0 1 0
T o
1 0
/ 1 2
/ 2 0 1 0
T o
1 1
/ 3
/ 2 0 1 1
T o
1 0
/ 0 6
/ 2 0 1 1
T o
9 / 0 9
/ 2 0 1 1
T o
9 / 1 2
/ 2 0 1 1
T o
9 / 0 3
/ 2 0 1 2
T o
8 / 0 6
/ 2 0 1 2
T o
7 / 0 9
/ 2 0 1 2
T o
7 / 1 2
/ 2 0 1 2
T o
8 / 3
/ 2 0 1 3
T o
0 7
/ 6
/ 2 0 1 3
T o
3 0
/ 8
/ 2 0 1 3
T o
6 / 1 2
/ 2 0 1 3
T o
1 4
/ 2
/ 2 0 1 4
T o
1 6
/ 5
/ 2 0 1 4
% s
t a n
d a r d
d e v i a t i o n
Topix vs Global Equities YEN52W IR & IR forecast trend
IR (52W) IR (36W) projected
Normal upper
normal lower level
forecast
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8/13/2019 2013 Review & 2014 Outlook
21/21
21
IN CONCLUSION
Tactical Overview : Equities and risk assets have been drifting in mean-reversion terms sinceMay. This indicates that markets have been in search of reassurance on Fed Policy . The Fedsrecent Taper move allows for a sharp Global Equity bounce of 4.5% in GBP terms (5.5% in
USD).
Tactically : There looks to be less mean-reversion scope (a typical mean-reversion bouncefrom these levels would imply 10% upside), and we think this is consistent with our longer runmodels that point to further drift through H1 2014...
Strategic Overview : Risk reduction is now fully priced, and Global Equities are trying totransition to a new asset pricing environment where equity duration is priced. But, whereas2013 began with too much pessimism, 2014 will begin with too much Optimism. The balanceof risk/reward does not favour reward.
Our main forecast is for a period of equity correction. Something much sharper than seen in2013 (c. 5-8% for US equities in USD terms, -15% for Japanese equities), although this shouldoccur in several phases with the lows occurring in May 2014. This will set equities up for asharp rally.
Strategically : The consensus sees 2014 as an inflection point for US monetary policy and forstrengthening growth, at least in the DMs. We see the outlook as much m
