Post Election - Why Trends Matter More Than Ever ft. Alan Dunne

[00:00:01] Intro

You’re about to join Niels Kaastrup-Larsen on a raw and honest journey into the world of systematic investing and learn about the most dependable and consistent, yet often overlooked investment strategy. Welcome to the Systematic Investor Series.

[00:00:23] Niels

Welcome and welcome back to this week’s edition of the Systematic Investor series with Alan Dunne and I, Niels Kaastrup-Larsen, where each week we take the pulse of the global markets through the lens of a rules based investor. Alan, wonderful to be back with you this week. How are you doing?

[00:00:37] Alan

I’m good, Niels, all good here in Dublin. How are you doing?

[00:00:40] Niels

Not too bad. Probably a bit jet lagged as you and I talked about beforehand. But I’m sure the riveting topics we’re going to be discussing today will keep me right awake and very alert for sure. Now we do have a question, but we also have a number of topics that we need to tackle today.

It has certainly not been an uninteresting period we’ve just gone through and are still going through to say the least. Now, as we always do before we dive into the topics, I’m curious to hear what’s been on your radar since we last spoke.

[00:01:15] Alan

Well, there’s a lot going on obviously, and I know we’ll talk about the elections and all of that in a moment. But another thing that I’ve been following with interest lately is in Europe. The last time I was on we spoke about Draghi’s report to revitalize the European economy and there’s been a couple of developments since then in that whole context. There’s been an ongoing saga in Germany around Volkswagen and the challenge that the German auto industry has been experiencing. And Volkswagen had a proposal to close three factories in Germany and cut their workforce and cut pay, I think by 10%. I understand there are similar challenges in Italy for the owner of Opal and Fiat. So, it’s just interesting.

The car industry in Europe employs 14 million people and we’ve got this challenge in Europe from the influx of EVs, in particular from China. So, it’s certainly a structural theme we have been talking about and I’ve been talking with various guests on the Global Macro series. So, interesting to see how that Volkswagen scenario unfolds.

And then yesterday we had the news that it looks like the German government is going to unravel. There’s been a spat between the SPD and the FDP, the Free Democrats, around budget cuts.

So again, it speaks to another challenge in Europe around rising debt levels and fiscal consolidation and the tough choices that have to be made in Europe amid a backdrop of growth in the German economy that has been pretty flat for a few years now.

So, yeah, I think it really points to some of the challenges Europe has around uncompetitiveness, et cetera. And just relevant in the context of what we were talking about the last day, where the Draghi report is all aimed at solving some of these challenges, but they’re very much there to the fore, you know, and in contrast to, I guess, to all of the optimism (well, some of the optimism that we’ll talk about in the US that we’re seeing at the moment).

[00:03:19] Niels

It’s funny, I mean, this was actually on my list under the election analysis, and I can update you further because the German government has indeed collapsed just earlier today, and an election has been called for.

Yeah, it is interesting, and I was wondering, I mean, in light of the Trump victory, as you say, the optimism and from a corporate point of view, probably lower tax, all that. We’ll come to that. But just the fact that, wow, this is not going to make it easier for Europe. I mean, we’re already falling behind.

And I mean, I was wondering if all this EU bureaucracy that we have, trying to always have 27 countries kind of agree on things. As much as I agree that there are certain things that are great about the EU, I’m not sure it’s good for competitiveness, frankly. So, I think I’m not so optimistic, unfortunately, on Europe, even though some people say, oh yeah, it’s going to be great, but I can’t…

[00:04:20] Alan

No, I agree it’s kind of hard to be optimistic at the moment.

I mean, it’s just such a shift if you contrast Germany versus Ireland. When I was in university, everybody went to Germany to get a job during the summer and people worked in places like BMW and Volkswagen and Siemens and places like that. And that was just that Germany was so far ahead. Now you’ve got fiscal surpluses in Ireland and full employment and got the opposite situation. So, these cycles are long term cycles.

Obviously, you’ve got the policy paralysis that you’re talking about in Europe, but equally you have the demographic challenge as well with aging labor force, aging population and, you know, people, reticent about immigration, in terms of addressing that. And at the same time then productivity, you know, all of the leaders in the tech space are in the US. So, it’s policy paralysis one part of it, but it’s not the only problem. But yeah, it’s hard to make the bullish case on Europe, as far as I can see at the moment.

[00:05:24] Niels

Yeah, no, absolutely, fully agree. So, in terms of what’s been on my radar, all I can say is that I don’t have anything specific about the economy or the market or anything like that.

But what has been on my radar, for natural reasons, of course, is the fact that I spent the last week, and particularly the last weekend celebrating Dunn’s 50th anniversary. And it is an interesting time to kind of get to know a little bit more about the history and the culture and how a company has evolved.

The owner of Dunn had commissioned like a documentary, so a whole year or so where a film crew had gone back and found information and to tell the full story about Bill Dunn, the founder of Dunn, to us when we were there. It was quite fascinating, especially in the light of how different it was back then compared to how it is today. So anyways, that’s really been on my, on my radar.

All right, now we’re going to do some election analysis. And I was kind of joking with you, before we pressed record, that every time you hear ‘election analysis’, all the maps come out and all the detailed analysis about every single county and how they voted, et cetera, et cetera. So I am, of course, very excited to hear your election analysis and what it all means.

[00:06:48] Alan

Yeah, well, of course we’re not going to go to the wall county by county with the analysis. But I mean, a few, a few observations that, you know, not saying anything that probably anybody watching CNN for the last two days wouldn’t have picked up. But I mean, it’s just interesting. I suppose what has really surprised the markets, I think, is the magnitude of the win and the fact that it’s a clean sweep. Now, obviously, I think in the markets, a lot of people we were speaking to were saying we do think Trump is the more likely winner.

And that was reflected in the betting markets. It was about maybe 66% likelihood at one point or at least 55%, even when it tightened up a bit. So, he was seen as the more likely winner. But I think the general expectation was a tight race. And now it looks like it’s going to be a clean sweep in terms of the House and the Senate as well.

And I think just at the weekend, I don’t know if you were aware, there was a little bit of a swing back towards Harris. Again, just going into the election date, there was a poll in Iowa which had Harris three points ahead and people got very excited. And there was a narrative about the female vote, particularly over 65. And this is going to be a huge trend. It just goes to show there’s always a narrative to fit whatever piece of data has been put forward.

But yet again, it seems like the polls underestimated Trump’s support. You know, even the New York Times Siena polls, which were at the weekend, again just before Tuesday, had the swing states. I think Harris might have been ahead in two. A lot of them were very close.

Pennsylvania, I think, was a tie, you know, and ultimately, Trump polled much better than that. So, people will definitely say another black mark for the pollsters. And I mean, when you interpret it, it’s all easy in retrospect. If Harris had won, we’d all say, well, it was, of course, the abortion theme or whatever. Now that Trump has won, in retrospect, people say it’s the economy, stupid. And yes, it was yet again the main theme. It’s hard for the Democrats to get away from the fact that they had high inflation during that period.

So, you know, all of the polls indicated how unpopular and how challenging that high inflation has been in terms of the popular narrative. Obviously, you could say the US economy is doing very well, full employment, etc. The stock market is at record highs, but high inflation, and particularly grocery food prices, that’s really been a theme that has come through.

You could certainly say that the Democrats made some tactical errors with respect to Biden being late to come out of the race, and then Harris got anointed. They didn’t have a competitive process. And even the selection of VP not going with Shapiro.

So certainly, you could argue in favor of some errors being made there. But, yeah, maybe just came to the economy.

And I suppose across the world, we’re seeing a general trend of governments being voted out after a term. And that’s going to be the pattern in the US as well. So, after the fact it’s all obvious. Trump was the more likely winner going into it. But the win proved to be much more in magnitude, so certainly a surprise from that perspective.

[00:10:16] Niels

Yeah, I mean, there’s a lot of thoughts, and of course, we’re not trying to make a political statement here. Lots of thoughts on that I had. First of all, I was actually in West Palm beach up until Monday when they were starting to cordon off the places where he was going to be in fear of any issues. So, I certainly felt the uncertainty and the tension, let’s put it that way.

However, a couple of things. First of all, if you went back like a couple of years, or maybe even a year, and you looked at all the legal problems he was facing, you would think it’s very unlikely that he’s going to win the presidency and he does it. So, I mean, that is interesting and something to learn from, I guess.

The other thing I was thinking of is you mentioned this problem about inflation, and I agree. I think that’s played a huge role. What I haven’t heard in the campaign, or the Democratic campaign, was maybe an explanation that actually inflation was caused, probably from COVID to a large extent. Which is something that first of all started during Trump’s presidency, and maybe the Fed made some mistakes and fueled it. So, that’s another thing. Again, not trying to make a political point. I thought it was interesting that that wasn’t really rebutted, firmly.

Anyway, some of the other thoughts I had about this, this is very random, I’m just going to throw them at you and you can kind of pick and choose what to respond to. From a completely kind of selfish point of view, I was thinking, how big a role did podcasts play in the election? Right? As news media, people know nowadays that if you open CNN, it’s one color. If you open Fox, it’s another color, and so on and so forth. But how about the podcast? How about these independents?

Even though Joe Rogan clearly came out in favor of Trump later on. I listened to it. I actually spent two hours listening to that conversation just to see what it would be like. And I think Harris should have done that as well, because I think he’s more interested in the person and the conversation than making necessarily political points. But I think actually podcasts did play a role this time around. That’s one thing.

There’s a lot of promises that have been made by Trump that I’m very interested in. He said that he’s going to open up the JFK files now that RFK is likely to be in his government in some role, probably health.

He probably can’t go back on that. And what does an RFK junior Mean? Not just for the health system, but for Big Pharma. I mean, he’s not a fan, as far as I can tell.

What about Elon Musk? It’s kind of interesting. I have kind of mixed emotions Here, a billionaire who owns Twitter in some kind of official role. I mean, what possibly could go wrong here? But it is interesting because he has done things, whether you like him or not, he has done things that no other person has been able to create, to do.

And we were talking about this, what it means for us, competitiveness versus other countries in Europe. Having Musk somewhere in the shadows probably doesn’t bode well for Europe, I would imagine.

What about tariffs? What kind of tariffs is the world going to face? I mean, we’ve heard some big numbers. We know he loves the word tariffs. It’s his favorite word in the dictionary, I think he has said. That’s going to be interesting.

And how does Jerome Powell feel about having Trump back in his life? I’m just wondering on election night, was he saying, ooh, okay, I’m going to have to deal with this?

And the other thing I kind of thought of, when I was sort of thinking about our conversation today was just the amount of money, the billions of dollars that has been spent on these two campaigns. It’s incredible.

But if you think about it, despite all the money Elon Musk has spent on this and all his sweepstakes or whatever it is he’s done, it looks like, according to Bloomberg, that he added $26.5 billion to his net worth yesterday. So pretty good investment, as far as I can tell. Those were my thoughts. Alan, I’m curious to hear whether any of these…

[00:14:58] Alan

Yeah, I think they’re all things in my mind. And interestingly, I read an analysis from Pippa Malmgren, who’s been a guest here. It was on the day of the election that I read it. I think, and she forecast a Trump win. So, she was right. And she was mentioning the podcasts, how podcasts have been more important.

Trump doing the podcast, Harris going on Saturday Night Live, you know, staying with the mainstream media. That’s kind of shown how out of touch Democrats were and not so influential anymore. It’s the podcasts, you know, everybody listening, listening into us, obviously. So that’s one thing.

And he also highlighted Robert Kennedy as a key swing variable that was in favor of Trump. So, there are two things, certainly. And I would say the use of Twitter is in that domain as well of what is influential for people. Yeah.

Elon Musk, I don’t know. I don’t have a strong view on the guy. He’s being brought in on this cost cutting exercise, I imagine it’s going to be hugely complicated, but even bringing in that focus could be hugely significant in terms of finding something in terms of productivity enhancements. I mean, there are loads of funny conflicts going on.

There was a Wall Street Journal article, I think, the week before, about how Elon Musk had multiple contacts with Putin over the last number of years. So, I mean, what’s that all about? You’d have to wonder. So, I don’t know where that plays out, but clearly he’s made a calculated bet. At the moment it looks like it’s come good for him.

Tariffs. Yeah, I mean, we’ll talk about the economy a bit. The question is, are tariffs the end game or are tariffs kind of a bargaining chip? I think it’s more the latter, but you can’t rule it out being part of the landscape.

And then Powell, obviously. Yeah, I agree. I mean, I’m sure his preference would probably have been for not to have Trump second guessing him or speaking. And even the person being proposed, or been talked about as treasury secretary, Scott Bessent, he also came up with this idea of the shadow Fed chair. So, you’d have this person who would be appointed two years time, or whatever, but would be kind of going around speaking, saying what he would be doing, which would be undermining the Fed.

So for a few reasons, I think Jerome Powell would certainly have preferred it not to have been Trump. But, you know, it remains to be seen what they can actually do. Then, on the money, yeah obviously, it’s entirely a productive use. But Harris had actually raised a whole lot more, hadn’t she?

[00:17:59] Niels

Yeah, 1.2 billion.

[00:18:01] Alan

So, it just shows you that it’s not just about that, it’s how you spend it.

[00:18:10] Niels

All right, well, we’re going to talk about global macro. Let’s see where you are. You had some super interesting guests, by the way, on your series recently. Louis Gave, of course, always super interesting. Jason Furman, Stephen Miran, there’s, you know, a lot of things going on in our Wednesday episodes at the moment. So, tell me how you see things at the moment with all that’s going on.

[00:18:33] Alan

Yeah, it’s interesting. I mean, it’s been couple of months since we were last spoke, and, I guess back in August, certainly into September, the US Recession risk was much more elevated. It was starting to diminish and it probably reached a peak kind of in August. But certainly the concern about downside risks to growth were certainly strong enough at that point obviously to encourage expectations of Fed easing, which the Fed delivered on in September.

I think taking a step back, looking at all of the data we’ve seen over the last number of months, obviously it’s been choppy and related or influenced by the storms, and port strikes, and Boeing strikes. So, there are a number of different factors. But you know, clearly there’s been an ongoing softening in the labor market, but not a massive softening, but certainly coming back into equilibrium or better balance. And, generally, the view being concerns about downside risks to that could be the harbinger or something more significant.

But against that, you know, we’re seeing certainly plenty of evidence of solid economic growth. You know, the latest services ISM number was the strongest since the middle of 2022. The consumer spending number is still tracking around 3% annualized in real terms. So, retail sales have held up. So, there are no real signs, manufacturing has obviously been weak but on the consumer side there are no real signs of a slowdown.

So, the labor market remains to be critical in all of this. And you know, you can view the labor market as leading and lagging. It tends to be lagging in terms of the economy slows down and then people pull back. But at the same time, if corporates, for whatever reason, dramatically slowed in hiring and started to lay off people, then that would lead into weaker consumption and that’s the threat. But at the moment I think there are reasons to believe that it could be just the labor market coming back into better alignment.

One thing that I have picked up reading some reports is that there has been a sense of caution going into the election. So, the election could have been a factor that has caused people just to pause for a while.

So, to the extent that if there is corporate optimism and business optimism coming out of the certainty of the election, it’s not inconceivable that could be a positive from an economic perspective as well. So, it’s inconclusive I would say. Certainly, growth is chugging along, inflation continues to come down, it’s still a little bit sticky. Core PC is still about 2.6%, 2.7% year-on-year. But if you looked at the six-month annualized, it is still tracking lower. So, it’s still a fairly positive outlook from the US perspective.

We talked about that Europe continued to face challenges, and obviously we’ve had the policy measures out of China, which have been largely aimed, I think I would say, more aimed at kind of stabilizing asset markets and putting a floor over under asset markets rather than being sufficient to encourage any optimism about a significant change in the growth profile over the next number of years.

So, it’s interesting if you look at things, in aggregate, from kind of an asset market perspective, it’s kind of, not a usual cycle, I would say, in the sense that you’re seeing equities rising, bond yields also rising, which would normally be consistent with kind of a reflationary type scenario which we’re seeing in some senses. But at the same time, you look at things like industrial commodities, oil prices have generally been falling. They rebounded a little bit recently. And obviously copper, industrial commodities like growth sensitive commodities like that had a run up earlier in the year but have come back down. So, there’s no real sign of strong demand there.

So, I do think, looking at markets at the moment, overseen in terms of the equity market rally, obviously, this week, and bond markets are much more a reflection of people thinking ahead to what the economy is going to look like under a new Trump administration as opposed to reflecting, so much, the current trajectory in the economy. So, I think it’s worth talking about that. We have had many conversations about what a Trump win might look like. We’re here now, so what does it mean?

You know, we talked about tariffs, so I think that’s obviously been the kind of the headline policy that’s been talked about. Now it seems obvious that higher tariffs would be inflationary. Obviously, it pushes up prices, but it is a one off effect in the sense that you raise tariffs and the price goes up, but it doesn’t necessarily mean the prices will continue to go up, which inflation measures the rate of change. So, there’s a question as to how the Fed would respond to that.

You know, would the Fed respond to higher immediate inflation or would they look through to say, well it’s not going to be sustained as long as inflation expectations are not altered. So, I mean, I’m not sure. I have more of a wait and see opinion on the tariffs to be honest, because I think they are more of a bargaining chip as opposed to really the end game. So, it’s possible that there’s a lot of bluster around tariffs, but ultimately you could get a deal between the US And China in particular..

Bear in mind that we did get a deal between the US and China last time around, I think in ‘20, late 2019, 2020, but it just got pushed aside when Covid came in. I think the interesting thing that probably the market is jumping on is optimism around supply side policy.

And this is something that came out when I spoke to Stephen Miran, it was just out this week, and he was a policy advisor under the last Trump administration. And you know, the words like deregulation are bandied around a lot. So, it’s hard to know what’s meant sometimes. But there are some tangible ideas there. Obviously, tax cuts is part of it, but also in terms of kind of less regulations, less red tape around various things.

So, I think that’s going to be the focus and that’s why it’s a potential positive from an economic perspective. Obviously, the supply side idea is that it boosts aggregate supply, it’s positive for growth, but doesn’t push up in inflation. I think obviously the tax cuts are going to get extended. Whether he can move forward with reducing the corporate tax rate to 15%, possibly.

I mean, it is an unusual situation, what we have now, in that you basically have two years of carte blanche because you’re likely to have the House and the Senate for two years and then obviously the electorate can come back.

Now, in theory there are certain things that you need 60 votes in the Senate, but practically there’s a thing called reconciliation process, which means you can do a lot on the budget side without that. So, effectively they have carte blanche to do what they like.

Now that said, the Wall Street Journal had an article yesterday highlighting that there is a bunch of Republicans, kind of the McConnell faction under Mitch McConnell, who are more moderate. So, you know, it’s not to say that they’re going to just go rampant in terms of cutting spending and taxes. There will be some moderation there. But certainly the policy mix of lower taxes, deregulation, whether to do anything on spending cuts or not, you have to say that looks positive for economic growth. And obviously that’s what’s been reflected in bond yields at the moment.

And I think we’ve had a decent run up since the Fed cut rates by 50 basis points, 10-year yields have jumped by, I don’t know, 60, 70 basis points. So, they’ve gone completely in the opposite direction. And I think that’s reflecting the concerns about deficit.

So interestingly, Scott Bessent, who I mentioned, he was a former hedge fund manager, he traded for Soros, he had his own fund, Macro Fund. Now it seems to me he’s been mentioned as the favorite at this stage, I think, to be Treasury Secretary.

I mean, I think he could moderate some of Trump’s impulses to some extent. If you go back, Trump had been very much kind of bashing and saying he wanted a weaker dollar, but he’s moderated that view.

And I’ve seen Bessent saying a strong dollar is kind of in the US’s interests. And also, I’ve heard him talking about reducing the deficit 3%. So, it’s possible that Trump might surprise in the deficit. I don’t know, but I’d like to see who he puts in, in terms of Treasury Secretary.

But they could decide to aggressively cut spending which would be kind of consistent with… Maybe Elon Musk finding some savings to be cut and that wouldn’t be so negative for the deficit.

The one thing I would say, from all the conversations I’ve had on global macro, I’d say nearly the thing that nearly everybody agrees on is the upside risk to bond yields over time and how unsustainable the trajectory of spending and deficits is in the US at the moment. So, certainly something would have to be done or else. Yeah, that’s the path of least resistance.

[00:28:00] Niels

Yeah. And speaking of that, it seemed to me that even people whom I assume, I can’t speak for them, but I assume that some of the very famous big global macro hedge fund managers that we see on television from time to time basically have been out saying, actually, regardless of who wins the election, these levels of deficits, deficits are unlikely going to be reduced dramatically and certainly not enough to make any difference to the long term debt trajectory. And as you say, it is unsustainable.

I actually read just now, before going on with you, an article where one of your also your previous guest Ed Yardeni was mentioned, saying that he sees 10-year yields, they could surpass 5%. And also, as you alluded to, bond yields really started to rise on the day, pretty much, of the 50 basis points cut. So, it has really been an ongoing goal, in that respect if the purpose was to try and get lower yields across the curve.

I noticed that JP Morgan has been out making some revisions now, saying that maybe the Fed will only cut every other meeting now, and they’ll probably stop now, at three and a half instead of three. So, it’ll be very interesting and I think the other thing, without making it too much about trend following per se, but I do think we are in for a very, how should I put it, it’s an interesting environment for these type of strategies where we don’t really have any prediction in terms of what’s going to happen.

I think that it’s going to be much harder, necessarily, to forecast just based on kind of gut feel, and discretion, and reading some economic reports, as to how the markets will react to some of these things.

Right now, it does feel like equities might end up in one of these kind of parabolic moves to end, possibly end, this enormously long bull market that we’ve had. But I felt that for a while this might be the trigger for that to occur. But who knows? It’s very interesting.

[00:30:31] Alan

Yeah, I think you’re right. I mean one thing that I would say, you know, if you go back to the 1990s when Clinton came in, I mean there was kind of a meeting between Clinton and Greenspan, at the time, where Greenspan kind of made a point that if you can get the deficit down, then that leads to a greater backdrop for us to co-rate, or keep rates easier. So, I raised this point with Jason Furman, would you see that scenario? But I was saying I don’t really think you could see that scenario between Powell and Trump. But he was saying, well, maybe. So, it doesn’t seem plausible.

But, that’s one of my takes, I mean that ultimately the challenge with the deficits gets resolved either with some kind of fiscal crisis, you know, the bond market vigilantes enforce it, or else there’s a shift in the political leaning on it. So, there’s no sign of that at the moment, but we’ll, we’ll see.

[00:31:29] Niels

Maybe you need to ask Ed back and get an explanation as to…

[00:31:33] Alan

Yeah, well, he’s the one who coined bond vigilante.

[00:31:36] Niels

Yeah, he did indeed. He did indeed. All right, well let’s move on to the next topic which is always our little trend following update.

Since I was not here last week and you and Andrew talked just about, or recorded just around the end of the month, but maybe not at the last day. I can’t remember if you had the last day, but it was a pretty ugly month for trend followers in October.

November looks a little bit brighter, so to speak. But I just wanted to add a few words to this. First of all, I would say, if I think about performance this year, there’s already been a couple of big months. They were to the upside early in the year and now we have October is, I think, probably the worst month so far to the downside.

But we also need to think about What actually took place to cause such a negative return? And it was really like the triple witching, I think is a word you use in option markets, right? Or something like that. And you had all three of the financial sectors turning against you at the same time.

The fixed income, as we’ve talked about, basically made a high point, in terms of price around the Fed cut, and has been selling off pretty meaningfully ever since. Equities, sure, the US equities didn’t lose that much in October, but other markets did, so that was pretty painful as well.

And then you had the currencies where, again, the US dollar had been sold against a number of currencies and suddenly it started to strengthen. So, you had all three of the big financial sectors that, regardless of how diversified you are, they are the bigger ones usually. And so even if, you know, lean hogs had a great month, it’s just not going to offset all the other stuff that’s going on.

So, it’s not unusual, in my opinion, that you see a big amplitude in performance when you have these three sectors moving kind of in the same direction, meaning either with or against the trend at the same time. So that’s kind of how I see it. Clearly, had you had some of the shorter term time frames, you would probably have done better.

But I did notice on some data, that I have access to, that kind of the middle section, kind of medium-term time frames (and here I’m thinking, look back) did, actually, even worse than the longer term time frame. So, it really was a tricky period.

What’s also really interesting is that we did see the bond exposure going from short to long in around June, July, late June, early July. And managers have, I think, built up a fairly meaningful, long exposure going into the Fed meeting. And obviously that’s what’s hurting. But now it seems to me that maybe some of these models are actually going short bonds again.

And so, it’s kind of a year with lots of transitions, in particular in fixed income. And fixed income, for what it’s worth, it’s a super important sector not just in its own right, in terms of the performance attribution, but also the correlation impact it has on other positions in a trend following portfolio if you use any kind of correlation analysis.

So, I don’t know if you have any thoughts on what’s been going on in Trend land, or in CTA land more broadly, in the last month or so, but that’s kind of how I saw or see the current environment.

[00:35:14] Alan

No, I’d agree. I think, if you’d asked me, I would say the bond section has been the one that’s been difficult. You know, if you look at it at the end of last year, managers would have been short. Then we had a squeeze into December and January, and some would have turned long, and then it went down again into March, April, and then back up, as you say, into August, September and people turning long again. So, the amplitude of the moves has been just long enough and big enough to entice people to switch positions.

So, I think, as you say, depending on if you’re medium term, that’s probably been the worst. Faster or slower has probably been better. And certainly, you see that in terms of dispersion, It hasn’t been a very good start to the year.

Now it’s turned into a challenging year, largely based on, I would say, obviously, I give back in currencies during the summer, but fixed income has been the big swing variable, if you were to look at it across managers.

[00:36:18] Niels

Yeah. So, it’ll be interesting to see whether we get some good into the rest of the year, now that we have some clarity in terms of who’s going to be in the White House. That’s all ahead of us.

In the first couple of days of November as of Tuesday night because we’re recording on a Thursday today. The BTOP50 is flat for the month of November. It’s up 1.91% for the year. SocGen CTA index also flat, down 6 basis points and down 78 basis points for the year. SocGenTrend also flat, up 13 basis points, down almost 2% for the year. And the Short-Term Traders Index hit hardest this month so far, down 1% and down 0.36% so far this year.

Of course, in equity land, all is good. MSCI World up 2.88% as of last night, up 18.39%. The S&P Global Developed Sovereign Bond Index not doing so well, down 42 basis points already in November, up 49 basis points only for the year. And the S&P 500 up almost 4% so far in November, up 25.73% so far.

Now, before we jump into the main topics, we had a question in from Yan.

Yan writes, I have a question you might want to explore in an upcoming episode. I’m a European retail investor working on building a DIY diversified portfolio. The usual guidance is to include bonds to add stability. However, I have a growing concern about the potential for long-term rising yields due to the increasing amount of sovereign debt issued. (You would imagine he’s listened to some of our conversations. Alan.)

Anyways, with that with that in mind, I’m wondering if, for portfolio stability, it might make sense to replace bonds with outcome defined or buffered ETFs. These ETFs limit potential stock market upside but do provide significant downside protection.

Their expected returns appear to align or be higher than bonds around 4% to 6% per year versus 2 to 3% per year according to ChatGPT. (Okay, not sure I want to take too much advice from ChatGPT on this point, but anyways, I’ll trust the data, if you say so), but they offer protection against market declines which bonds might not match if interest rates climb substantially in the coming years. Any thoughts?

And of course I turn to you as the expert in buffer ETFs. Alan.

[00:38:53] Alan

I have to say I did have to look up buffer. I never thought of asking ChatGPT. I should have got his analysis. I kind of had been vaguely aware of them because they’re basically structured products, capital guaranteed products wrapped in an ETF.

[00:39:13] Niels

Which you talked about…

[00:39:16] Alan

Which we talked about last week with Andrew. And you know, I followed that market in the past, to an extent. You know, with capital guaranteed products, normally you get some upside, you buy an option to get some participation in the upside of an index and you have varying degrees. You might have full capital protection on the downside or what’s called soft protection. These are products where you’re wrapping the structured product in an ETF. There is the same amount, and you can get some level of protection. The protection is for a given period. So, the amount of it depends on when you come in and buy the product.

But broadly speaking, what Yan says is correct.

Now would I use them as an alternative to bonds? Maybe not. It depends on the nature of the downside protection. My understanding is some of them might give you 10% protection or 15% protection. So, protection for the first 10%, 15% decline in the index, but you have full participation in losses beyond there. So, you would still have a big tail risk. I mean bonds in your portfolio had a particular role of stability but also convexity in terms of, in a significant equity sell off you have something in the portfolio that would do particularly well.

So obviously, our typical answer in a situation like this would be trend following or managed futures, not buffered ETFs. And that is strictly still the right answer. But I understand it can be difficult for retail investors to get access to trend following products even in USITS. But yeah, so that would be the solution. I mean, you know, I would be cautious about the buffered ETF in terms of understanding what level of protection you have. And yeah, even then you might be getting protection but you’re not going to necessarily get upside. The alternative would just be to shorten the duration of bonds, which is effectively like holding cash or bills.

Again, you don’t get the convexity from that but you do have an income generating assets and some stability. So yeah, I’d be cautious if you can access trend following, it’s a much more sensible solution, I would have said, but conscious of that it can be tricky in a retail context.

[00:41:40] Niels

Couldn’t have said it any better, Alan. Thank you very much for doing that.

Now, we’ll see if we get to all three papers that we had, or four, because there’s a mystery paper out there, but let’s see how we go on.

We decided to start out with a new Goldman Sachs paper, or report, Updating Our Long-Term Return Forecast for US Equities to Incorporate the Current High Level Of Market Concentration, I think was the long title of the paper. Talk to me about that and what your sort of key takeaways were from their update.

[00:42:17] Alan

Yeah, well I’ve talked about these kinds of papers a number of times before. We’ve had like JP Morgan, Capital Market Assumptions, and you know, and they came out with a paper like this, at the end of last year, saying you know, the 10-year returns in the S&P that we’ve experienced are unlikely to be continued. You get the likes of GMO who publish periodically their seven-year asset class returns. You know, when I talked to him about this whole issue. So, it’s always an interesting topic, people making a forecast for 10 years as opposed to what’s your forecast for the S&P for year-end, or year-end next year?

And this one’s particularly interesting I think. I mean, it’s notable coming from Goldman. We normally say, you know, security houses, brokerages, banks, they’re always bullish, they’re always peddling a positive narrative.
So, for Goldman to come out and say they actually think annualized returns of 3%. Now, maybe it’s to boost their sales of alternative products or something, who knows, but it’s an interesting conclusion. What’s really interesting about it is that it’s not unusual, as I say, you do get a wide variety of views, it’s not unusual to have some on the low side. What’s really interesting about this is the importance they place on concentration of the S&P 500 index.

So, I mean the key takeaways were that they’re forecasting 3% annualized. That’s nominal returns for the S&P for the next 10 years. That’s 1% real. That would put it in the 7th percentile of 10-year returns going back to 1930. So, you know, 93% of 10 year periods would have been better. Now, their margin of error, they could see it anywhere between minus 1 and plus 7.

So, the point forecast is 3, but they could say it could be minus 1% annualized, or plus 7% annualized. That would be a reasonable range of estimates. And as I say, concentration is really a big theme of this.

What I mean by concentration is the fact that technology accounts for whatever it is, 30% plus of the index. They actually think that the equally weighted S&P 500 will outperform by between 2% to 8% annualized. So, what’s that? So, it’s about 5%. Add the 5% back to the 3% and that’s 8%. That’s a pretty normal kind of equity forecast for the equally weighted S&P 500. With 10-year yields at about 4%, there’s quite a good chance that bonds will outperform equities based on their forecast.

So yeah, as I say, the debate about concentration is interesting. So, what they find is that when you get this concentration in the index, it tends to be associated with greater volatility then going forward and it tends to be associated with lower 10-year returns going forward.

And the reason is obviously when companies become concentrated, or the index becomes concentrated, and these companies get so big, then it’s like, how can these big companies sustain such strong earnings growth? You know, it’s easy for a smaller company to grow their earnings and the revenues more strongly, but the economy is only so big.

So, if you’re already 30% of the index, can you really grow at 7% to 10% per annum? And for context, I think that over the last 10 years earnings grew at 7% annualized. So, it has been a good period. Not only have earnings grown at 7%, but you’ve had lower taxes, higher sales, and higher margins all contributing to that. And multiples have expanded as well.

What’s interesting about this is, as I say, we’ve had other papers like this. Generally, the differences in what you get, in terms of your end forecast depend on things like your assumption around will margins normalize or what’s going to happen to bond yields? Obviously, if bond yields jumped up, that would justify lower returns or else maybe your forecast on the economy. Within this report, they’re assuming that the economy is going to contract in four quarters, so 10% of the time in the next 10 years. It’s not overly pessimistic. So, as I say, the real swing variable here is around the concentration issue.

It’s a tough question to answer in the sense that they say, yeah, it’s unlikely to be continued, but there is obviously a view out there. These companies now have such significant moats. They have businesses that are bigger than many countries GDP, they have huge cash balances, they have the resources to invest in new technology. So, they can harness AI to a much greater extent.

There are arguments out there for why it can continue even though Goldman are making the case, which seems plausible, that it is unlikely to continue. My sense on it is it feels like, with respect to a lot of this technology, the winners are priced, but not necessarily the impact on the losers.

Personally, I do think a lot depends on yield. So, even Goldman’s concentration argument aside, if we were into a higher yield environment, that in itself would justify lower valuations and reversion to the mean in terms of valuations. And prudence would dictate not to expect the kind of the same level of returns that we’ve experienced in equities over the last 10 years and probably a below average return.

But as you say, you know, I think you said a moment ago, it feels like we’ve been expecting this kind of reversion for a long time and that’s certainly the case. So, I’d agree with that.

[00:48:06] Niels

Yeah. I mean, it’s interesting. I mean, obviously, one should always pay attention to what a house like Goldman comes out with. They’re smart people.

There are a few things. First of all, instead of reading this report, Alan, maybe we should read the report they wrote 10 years ago and see if they were right about that report in a sense.

[00:48:23] Alan

Yeah, they do, actually. I’d have to pull it out, but they reference how they’ve changed their model, I think since 10 years ago, but their model would have been not as optimistic, but optimistic. But it would have undershot in terms of what equities actually delivered. But they do touch on that in the report.

[00:48:38] Niels

Yeah, because, I mean, one of the things that has been a little bit of a puzzle, I guess, for many people, including I’m guessing the two of us, is that, yeah, everybody said, well, higher, higher, higher inflation, higher yields will definitely put a damper on equities. Well, guess what, it hasn’t. And the S&P is doing pretty well this year.

So, that’s one thing. It just feels like some of these old-school mechanics, even though it’s kind of logical you would think, well, if borrowing cost goes up, it shouldn’t be great for companies, but they have. And I also wonder whether the whole concentration, as people know, no surprise, I’m not an equity guy here.

It’s just me thinking out loud on this whole concentration issue. A couple of thoughts on that one. Nobody said, five years ago, that a small company called Nvidia would suddenly become the most valuable company, or one of the most valuable companies in the world in a short space of time. So, things do change, right? It’s not like we can just look at the top 10 companies today and say, oh yeah, there’ll be the top 10 in 10 years time.

So, I’m not sure about whether the concentration, I mean clearly it can lead to more volatility. I do agree with that. But whether it’s going to outperform or underperform, I actually have no clue whether it will.

And some of these companies obviously, take an Apple, I imagine they’re pretty cash rich. They’re not very indebted either. So does higher interest rate help, maybe, instead of dampening the potential? Again, I’m just raising these as questions where I think that it’s interesting.

And then, of course, they also go out, I think, in the report and say that they expect bonds to outperform equities. And that’s, in my own mental model right now, in terms of what I expect from inflation and all of these things. That, I think, is a difficult one as well to really buy into. But who’s to say they may well be right? The good thing is as trend followers, we don’t really need to be right about any prediction because we don’t make them. But it will be interesting without a doubt.

[00:50:59] Alan

Yeah, I think there is a tendency amongst investors to extrapolate what we’re seeing at the moment and assume its low. So, the equity rally in the last 10 years, it’s not like it’s just been rampant speculation without fundamental Basis. I mean earnings in these companies have grown very considerably.

It’s things like cloud computing that we didn’t have 10 years ago and Microsoft, in particular, you know, that’s been an important source for them as well. Or you know, as you say, a demand for sophisticated chips – Nvidia, I mean it wasn’t there 10 years ago.

You know, even phones, like the iPhone came along about 2010 or so. So, you know, the question is, where will the money be spent over the next 10 years? Will the earnings actually justify it?

Now obviously valuations did jump up over that period from, as they say in the report, 16 to 22 in terms of PE ratios. So, it’s unlikely that they’re going to go from 22 to 28. It’s not impossible. It could be, but they won’t necessarily come back to 16 but they might stay at the same level.

So, I mean it’s so hard to know. As I say, there are arguments on both sides. I do think, I mean their argument about bonds outperforming is purely based on if the 10-year yield is 4% then your expected return from bonds is 4% if you buy the 10-year and hold it to maturity. Whereas their forecasting 3%. So that’s the only argument there.

I mean the other thing to bear in mind is, you know, from our perspective, if you were to say trend following, if it’s a 0.4, 0.5 Sharpe, if something is running at 12 vol with interest rates at 3%, you know, that’s 7% or 8% expected returns for trend following, in the context of bonds at 4%. And they’re saying equities at 3%. So, as I said, it certainly supports the case for allocating more to alternatives.

But you know, we’ve been saying that, and we say it all the time, and it feels like a bit of a broken record sometimes. And I’m sure advisors, you know, will just say, well look… As I say, last week myself and Andrew were talking about how one Bloomberg report was saying it’s so hard to sell an alternative product at the moment because the S&P is doing 15% per annum, and the assumption is it’ll continue to do it. So yeah, I mean logic would tell you diversify, look for alternative sources of return. But it’s easy to understand why people just continue to hold these high flying assets.

[00:53:38] Niels

Sure. That’s very true. Speaking of kind of mixing asset allocation with a stint of systematic touch. There was a report out that I shared with you from Invesco. I think it’s called the 2024 Invesco Global Systematic Investing Study. And it provides some insights into how systematic investing has become integral, really, to portfolio construction and how these trends (pardon the pun) in data driven multi asset approaches, how they reflect on that. So, I’m curious what you thought about this. And yeah, generally speaking, maybe big picture.

[00:54:28] Alan

Yeah, I mean I was a bit surprised, to be honest, at the extent of the adoption of some of the strategies. So, this is a survey Invesco does of institutional and wholesale investors. So, institutional being kind of pension funds, insurers; wholesale being wealth managers, private banks, and sovereign wealth funds on the institutional side. And it’s nearly even between the two, a bit more tilted towards institutional.

I mean they cite, in terms of the adoption and use of systematic strategies, four kinds of themes: one, rising use of systematic strategies and multi asset portfolios; two, the evolution of multifactor investment strategies; three, AIs expanding role; and four, increased customization in the ESG space. So, there were two themes there that I was more interested in.

One was the use in multi asset portfolios, which was kind of interesting to see because normally my impression of a lot of multi asset funds are fairly vanilla, you know, always tend to be kind of 50%, 60% equities, 20% bonds, 10% credit, et cetera. But it does seem to be that greater adoption of systematic strategies.

Now interestingly, if you look into it, they’re saying 80% of the time that’s what’s called factor tilting strategies. And then I think in 67% of the cases it’s models or systematic approaches to asset class and sector rotation. And then trend following does get a mention, 44%. I think it’s 44% of respondents maybe using trend following in that context, which I thought was interesting. Also, vol targeting frameworks is 41%.

I mean they do mention, elsewhere in this area, that in the first instance systematic strategies generally apply to the equity element and increasingly has been applied to the fixed income side. They do say it’s also been applied to PE and real estate, which certainly did surprise me. I’m not sure exactly how systematic approaches are applied in that context.

But also, they mentioned, you know, increasing use of kind of risk parity frameworks and machine learning, and also the use of systematic approaches in commodities. So, as I say, my impression of the multi asset fund management world had been more vanilla. So, increasing to see that we’re seeing this increased use of quant strategies.

On the theme of the rising use of AI, I thought that was particularly interesting. They’re saying 90% of respondents are using AI in some shape or form in their investment process. Pattern recognition in market behavior is the most popular use.

So, using AI for sentiment analysis around news, and earnings calls. Using NLP on Twitter to assess sentiment, and also using AI to monitor and adjust positions in real time. So, I mean, yeah, I find that surprising to be honest.
Of all of the chat we’ve had with managers and people being somewhat skeptical on machine learning and okay, using it largely in terms of execution, that, in this kind of multi asset, asset allocation space where we’re seeing wider adoption of machine learning and AI. So that was certainly a surprise. What did you think?

[00:57:50] Niels

Yeah, I agree with that. I would not have expected that. But maybe it is different and maybe we think about these things a little bit differently from a manager’s perspective to someone like a multi asset fund, and how they would use these things. But we’ll see. I mean it’s going to be definitely on the rise.

I think the good thing is potentially here, is just the fact that people are perhaps unsurprising with the way technology goes, but they’re getting more comfortable (if adoption rate is any way to go by) with the idea of being systematic. I think the word systematic is often overlooked and certainly underappreciated.

We talk about trend following and the rules, the models, the diversification of the markets and all of that stuff, but we kind of forget maybe the actual core of it, and that is being systematic because it’s so boring to talk about. There’s nothing to say about it. It’s just you do what the model tells you to do, end of story.

But the power of being systematic, the power of following trends, I mean, as I said in the early part, we’ve just celebrated 50 years of being systematic. So, clearly there’s some evidence out there that these things are beneficial. So, if more and more people wake up to that, that’s probably a good thing.

Alan, we’re not going to get to the last paper. But I don’t want to overlook the mystery paper.

[00:59:23] Alan

Keep that one for next time.

[00:59:25] Niels

You want to keep the mystery paper as well?

[00:59:28] Alan

Yeah, I was going to keep it.

[00:59:29] Niels

Or do you want to tease it? Do you want to tease it?

[00:59:32] Alan

I was thinking about like it’s related to what we’re talking about with multi asset portfolios and the use of alternative investment strategies. So, I suppose what I’m thinking is, if you think about asset allocation and portfolio construction, we’re all very familiar with the idea of combining different assets to enhance the Sharpe ratio and enhance the risk adjusted return. And that’s pretty much kind of a Markovitz framework of finding the efficient frontier.

But there is a nuance there, when you’re adding alternative investment strategies to an existing portfolio and those strategies are trading the assets that you already hold. So, in the case of trend following, we always make the case, well, if you add trend following to a 60/40 portfolio, how does that impact the returns?

But you also have to think about not just that, in terms of alternative investment strategies, the fact that you’re getting additional exposures in some cases to those assets as well. So, it’s a nuanced picture. So, it’s something I plan to write a blog post on and maybe once I’ve fully fleshed it out, it might be worth talking about it in more detail.

[01:00:39] Niels

Yeah, if people didn’t catch on to it. The mystery paper is something that Alan himself is working on. So, that is why we definitely will talk about it as and when it is finished. But the last paper from Man we won’t get to today.

But who knows, maybe you will get to it next week, Alan, because once again I thank you for sitting in for me because, even though I only got back last night, I’m off tomorrow for Asia this time. So, the other side of the World. So, you kindly will be sitting in, and you’ll be discussing all matters of systematic investing with Mark next week.

And so, if you do have questions for Alan and Mark, then do send them to info@toptradersunplugged.com and we will make sure we cover those as well.

And if you enjoy these conversations and all the hard work that Alan and all the other co-hosts put into creating them, then do go and leave a rating and review on iTunes, Spotify, Amazon, wherever you listen to your podcast. We so appreciate that and it’s a good sign for us to see that you actually enjoy the content that we are putting out.

So, with this, from Alan and me, thanks ever so much for listening. We look forward to being back with you next week. And in the meantime, as usual, take care of yourself and take care of each other.

[01:01:59] Ending

Thanks for listening to the Systematic Investor podcast series. If you enjoy this series, go on over to iTunes and leave an honest rating and review. And be sure to listen to all the other episodes from Top Traders Unplugged.

If you have questions about systematic investing, send us an email with the word question in the subject line to info@toptradersunplugged.com, and we’ll try to get it on the show.

And remember, all the discussion that you have about investment performance is about the past. And past performance does not guarantee or even infer anything about future performance. Also understand that there’s a significant risk of financial loss with all investment strategies, and you need to request and understand the specific risks from the investment manager about their products before you make investment decisions. Thanks for spending some of your valuable time with us, and we’ll see you on the next episode of the Systematic Investor.