Understanding Global Macro Themes and Exploiting Them

Image result for Understanding Global Macro Themes and Exploiting ThemCapturing economic and financial market data and contextualizing it is something the Old Institution and its followers find very difficult to do. It takes a disciplined, time-tested approach to measure the slopes and extremes in economic and financial market data across several hundred markets in all four major asset classes across 27 economies globally. Beyond that, it takes a unique skill set to contextualize all that data to formulate accurate market calls.

Our macro themes are intended to focus your attention on the global macro trends that matter most at a given point in time and the markets most impacted by those trends.

The life cycle of a macro theme begins with: “Hey, here is a macro theme that’s impacting this particular market bullishly, we think you should trade it with this directional bias until further notice.”

If a macro theme remains active, we provide regular updates and actively manage the specific markets we trade based on that theme. When the Fundamental, Quantitative and Behavioral Gravities align for a market impacted by one of our macro themes and the reward-to-risk is skewed in our favor, we add it to our Focus Market list and begin to trade it.

Once the macro theme has run its course, or that market has exhausted its move, we alert you to that fact and begin looking elsewhere for opportunity.

One Objective, Two Questions

Our sole objective is to help you side-step dangers that no one else sees coming and help you position for opportunities that most investors miss.

While this objective is philosophical enough to make Plato proud, it’s also quantifiable by answering two questions: 1. During the time we recommended a Focus Market, did it generate a positive cumulative return? And 2. During the time a Focus Market was active, did the market’s largest move in our favor far outweigh the largest move against us?

If your head is swimming a bit here, no worries, this is a differentiated way of evaluating and being accountable to market calls. Let’s run through a case study.

Case Study: South Korea

On May 28, 2018, we initiated our “The Other Korea” macro theme with South Korean equities as a bearish Focus Market via the iShares MSCI South Korea ETF (EWY). On that day we said, “All three Gravities (Fundamental, Quantitative and Behavioral) are aligned and decidedly bearish, which means it’s time to put on a short trade and go huntin’ for wabbit.”

We carried that Focus Market trade until we closed the macro theme on Jan. 7, 2019 stating, “At this point in the game, the downside in South Korean equities is extremely limited, making it a no-go for further short selling. South Korean data continues to deteriorate, but we are de-activating this theme because there are better risk-adjusted opportunities elsewhere for our capital.”

After we closed that macro theme, we put on the big boy pants of accountability and asked ourselves those two critical questions to determine if we upheld our objective.

Did the Focus Market trade generate a positive cumulative return over the time frame we recommended it? From the close on May 29, 2018 (May 28 was a U.S. holiday) through Jan. 7, shorting EWY generated a +17.9% return.

During the time this market was on our Focus Market list, did the market’s largest move in our favor outweigh the largest move against us? Over the time of our recommendation, the most adverse move we experienced was -2.6% when EWY rallied to a peak of $73.55 on June 7, 2018, one week after we activated the market call. The maximum favorable return was 22.5% when EWY fell to a low of $55.58 four months later, on Oct. 29. When we compare the most favorable move to the most adverse, we get a reward-to-risk heavily skewed in our favor at 7.8-to-1.

Opportunity Knocks

To be clear, not every Focus Market call is an 8-to-1 winner, but overall, we’ve been much better than bad.

Since the beginning of 2018, we’ve had 34 closed Focus Market calls across nine different macro themes. The cumulative return of all 34 trades (with varying durations from 11 to 256 days) was +175.7%. The maximum favorable cumulative performance was +472.4%, while we experienced a cumulative adverse move of -168.9%. Based on these statistics, we provided an opportunity set with an overall reward-to-risk of 2.8-to-1, which means you experienced a $1 of drawdown on the way to gaining $2.80.

The best reward-to-risk was our short U.S. semiconductors call (June 18, 2018, through Jan. 7, 2019) at 30.5-to-1. Our worst call (-0.20-to-1) came this year during the two weeks we were short Australian equities via the “Winter Is Here” macro theme, and the iShares MSCI Australia ETF (EWA) moved against us -1.9%.

We currently have 14 open Focus Market trades, across four active macro themes. The cumulative return of all 14 Focus Market trades so far is +93.5%, with a maximum favorable cumulative return of +162.4%, and a cumulative adverse move of -58.9%.

The overall reward-to-risk of our open Focus Market opportunity set is identical to the trades we’ve already closed, 2.8-to-1. That’s the kind of symmetry that makes Melvin Udall as giddy as a toddler!

The total cumulative return of all 48 trades across the 13 macro themes from January 2018 through July 12, 2019, is +269.3% with a maximum favorable opportunity set of +634.8% and an adverse move of -227.8%, for an overall reward-to-risk of 2.8-to-1. Of those 48 trades, 20 (40%) offer reward-to-risk stats more than 4-to-1, and only two (4%) have delivered negative reward-to-risks. Moreover, across all open and closed trades, we’re clipping 60% winners with an average gain of +11.8% versus just a -4.0% loss in the 40% of unprofitable trades.

As context for the opportunity set, we’ve provided; let’s look at the S&P 500, the 60/40 equity-bond allocation and the All-Weather Portfolio.

Since Jan. 2, 2018, the S&P 500 has returned +15.1%, had a most favorable return of 15.1%, experienced an adverse move of 19.3% and has provided an overall reward-to-risk of 0.78-to-1. The asset allocator’s model of being 60% equity and 40% bonds has gained 11.4% (which is also its maximum gain) with a maximum drawdown of 11.6%, giving it an overall reward-to-risk of 0.98-to-1. And finally, Ray Dalio’s All-Weather Portfolio over that same time frame has gained 9.2%, had a most favorable return of 10.3%, experienced an adverse move of -6.2% and has provided an overall reward-to-risk of 1.6-to-1.

Bottom line, our macro themes and associated Focus Markets, consistently put us on the right side of big market moves, before they occur. More importantly, our timing has ensured that the negative impact of moves against our trade ideas has been minimal and more than palatable given the profitability.

Home Improvements

Going forward, we are making two Gravitational Edge changes we believe will improve both your decision making and our level of accountability.
First, we are expanding the Focus Markets table on page 5 to include:

  • The date the market was added to the Focus Market line-up
  • The P/L from the closing price the initial day
  • The maximum favorable return (how far it’s gone in our favor)
  • The maximum adverse performance (to what magnitude it’s moved against us)
  • The overall reward-to-risk (R-2-R) of that Focus Market trade.

These statistics will be updated each week to give a real-time assessment of how our market calls are performing.

Second, we are no longer tracking our best and worst G15 portfolio trades. While helping you catch a few fish here and there with our email alerts is fine, it’s far more critical for us to be accountable to our objective: do we consistently help you side-step dangers and position for opportunities?

For this reason, we are now going to document our best and worst macro theme-generated Focus Market trades. This change brings a new level of on-going transparency as to our ability to consistently send you to the best fishing holes where your odds of successfully catching dinner are heavily skewed in your favor and the time you sit looking at a limp line is minimized.

The Bottom Line

Our framework and our daily dedication to the global macro grind is the cornerstone of our success in sifting through the ever-increasing amount of noise surrounding financial markets to help you focus on the economic and financial market developments that truly drive risk and return.

I’m grateful for the trust you place in us each week. We will continue to improve our framework and as importantly, ensure those insights are delivered to you in a way that is easily digestible and profitably actionable.