Economics

The consensus is bullish. Yikes!

I attended Bloomberg’s ETF conference last week and presented on the Top Trade Ideas for 2018 panel. See picture below (I am the 3rd person from the left).
Do I look nervous? A bit….

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Why am I nervous in this pic? I have been personally bullish on risk assets for five plus years. Ever since 2012, I have been putting out top ETF trade ideas for the next year. It’s always been one of my most read pieces of my 18-year career of writing content and research. Since 2010, I have consistently written bullish ideas. However, the past few years I ran more hedged strategies.
So why am I concerned? Well, for one thing being bullish is now consensus. By definition, once something becomes consensus it should be “reflected in the price”. Once something is “in the price”, to outperform you need to:
1) Have an out of consensus view
2) Time your position accurately
3) Size your position appropriately
When I founded Astoria earlier this year, I wrote in the investor deck that the current environment was a dream scenario for stocks. Why?
1) Global earnings were inflecting higher globally
2) Liquidity was flowing tremendously (about $2.2 trillion of balance sheet expansion in ‘17)
3) Inflation was muted
What more can you ask for from an equity shareholder perspective?
So, what does that mean for 2018? Our models and indicators still suggest a reasonably high probability of risk assets performing well through Q1 and part of Q2 of 2018. However, we are worried about the rate of change declining for liquidity. That has me worried a lot!
Why? Markets trade on the margin and the rate of change is critical for investing. I think it’s obvious that the tremendous liquidity provided by central banks globally has been an enormous driver for risk assets in recent years (along with earnings). However, the liquidity component will now change in 2018; particularly on the margin.
What’s the investment implications? Timing the market is tricky and historically a poor risk/reward. We view market timing as a low probability event of having repeatable success. At Astoria, we look at probabilities and the distributions of outcomes constantly. Given that liquidity will decline in 2018, we are incorporating hedges in our portfolio so that we provide our investors with well diversified portfolios and attractive risk adjusted returns across varying economic environments.
It's easy to make $ when the market goes up 400% and 8 years in a row. Heck, people even find it attractive to give $ to a Robot who will invest based on historical trends and extrapolate forward. I can't think of a more dangerous way to invest.
My big picture point is that markets are forward looking, and the rate of change is everything. Next year Fed rate hikes, Quantitative Tightening, and other CBs slowing their QE purchases will result in a decline in liquidity. Are those robots picking up this decline in liquidity? 😊
I want to be clear. Astoria is constructive on risk assets. We have been all year and our investors have benefited accordingly. Literally, our playbook next year suggests Emerging Market equities & FX, Japan, Europe, International Small Caps, Global Value & Momentum are areas we like. We simply think its prudent to hedge these risk assets.
So, what are we using to hedge? Instruments such as QAI, TLT, ZROZ, and IAU. For now, these instruments are carrying well and some even have some nice asymmetry for our portfolios which we like. We are beginning with a small amount of hedges and will scale as our models indicate we should.
· And if you prefer to listen, check out this podcast that I did with Jeremy Schwartz, Director of Research at Wisdom Tree. You can listen here https://soundcloud.com/user-20931378/behind-the-markets-podcast-john-davi-bruce-lavine
Best, John Davi
Founder & CIO of Astoria
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