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Executive Summary
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Technical ProcessInvestment discipline helps manage risks and maintain decision-making consistency, ensuring alignment with long-term goals and reducing emotional biases. Incorporating trend indicators and understanding price dispersion have been key in timing investments and identifying undervalued assets, aiding in portfolio diversification.
However, relying on historical data for these strategies doesn't always predict future market behavior, and the market's efficiency can limit their effectiveness. These strategies also add complexity and costs, with risks of overfitting to past data and challenges in market timing. We also noticed that extreme dispersion does not always result in price movement back to the mean because of persistent trends that may develop. Instead of positioning solely on oversold/overbought signals, our work shows that blending indicators such as momentum, trend, and dispersion can help optimize investment strategies. While there are merits to trend following over the long-term, brief periods of volatility can increase drawdown risks. Mean reversion strategies can take advantage of wide dispersion in asset returns as trends weaken, albeit short-term. This was evident in the recent rally in US small-cap stocks, price corrections in some industrial metals, and a rise in equity volatility. Therefore, we recognize the importance of adapting strategies to various market environments. Disclaimer: The Content is for informational purposes only and does not reflect holdings. Information or other material is not investment advice.
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MACD/RSI Model
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Trend & MomentumThe MACD/RSI model, developed by Kyaw Swar Ye Myint, is designed to provide a comprehensive assessment of market trends and momentum. Instead of relying solely on an overbought/oversold indicator, the model attempts to measure renewed price strength within an existing bullish or bearish trend. Over time, some price trends may become too extended and experience a reversal. Z-scores can be used to measure price deviations from the historical average. While it is difficult to time an exact reversal point, long-term momentum shifts can aid in the gradual rotation away from decaying trends toward emerging trends. We found the MACD/RSI model to produce the best historical results in commodities and equity indices rather than currencies.
Kyaw's ATR/Stochastic model enhances currency trading strategies by combining Average True Range (ATR) and a Stochastic oscillator. ATR measures the degree of price volatility, providing insights into the normal price range movements, which helps in setting stop-loss and take-profit levels. The Stochastic oscillator, on the other hand, identifies overbought and oversold conditions, signaling potential reversal points. This combination offers a robust approach to capturing trends and reversals in currency pairs. FX: Recent applications of this model showed new long positions in BRL/USD and EUR/GBP as of the June close, reflecting potential shifts in market dynamics. These signals have recently moved from buy to hold as of the July close. The BRL/USD pair has demonstrated persistent weakness, moving from a Z-score of -0.81 in Q1 to -1.04 in Q2 indicating a potential move into oversold territory relative to its 10-year average exchange rate. Similarly, the EUR/GBP pair is near a neutral point with a Z-score of -0.01, suggesting stability and a possible entry point for traders looking for minimal volatility. Both pairs are trading near the bottom of intermediate-term ranges, suggesting that a brief period of mean reversion is possible. On the extreme end, USD/JPY is the most extended currency pair in our universe with a Z-score rising from 2.37 in Q1 to 2.68 in Q2, which preceded a sharp sell-off. While trend indicators remain intact, momentum has shifted to the downside, potentially targeting a return toward 120-125. Commodities: Notable price changes were observed in Copper Futures, whose Z-score has increased from 1.13 in Q1 to 1.60 in Q2, reinforcing the bullish uptrend that eventually faded around the 5.20 price level - a significant long-term upper-bound where previous uptrends began to deteriorate. Overall, some commodities are experiencing similar trend weakness, but we remain on watch for stabilization as bright spots emerge, particularly among active funds that are overweight gold given its long-term breakout. Equities: In global equities, Norway's Oslo Bors (OSEAX) Index remains above its breakout level achieved in February. Despite seasonal weakness, the index maintained positive long-term momentum and demonstrated improvement relative to the MSCI Europe Index. The Stoxx Europe 600 Index has shown significant strength, with a Z-score of 2.17, highlighting sustained momentum since the Q4 2023 long entry signaled by the MACD/RSI model. Similarly, the NIKKEI 225 Index has escalated to a Z-score of 2.89, suggesting robust performance relative to historical standards. European equities appear less extended versus their 10-year average price levels relative to Japanese equities. Conversely, the Hang Seng Index's Z-score improved from -2.34 in Q4 2023 to -1.55 as of the latest data. This improvement might suggest that negative momentum in Chinese and Hong Kong equities is decelerating, potentially nearing a point where a shift from a hold to a buy could be considered. Trends are starting to shift from extreme levels, which could be a source of volatility. In these environments, trend following systems typically struggle to adapt to shifting momentum. The insights provided by Z-score analyses and trend indicators may be helpful in navigating the complexities of various asset classes, from equities and commodities to currencies. By leveraging such tools, investors can better align their strategies with the prevailing market conditions, optimizing their potential for returns while managing risk. |
Dispersion Variability of recent price action to its 10-year average, ranked by product.
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Portfolio Process
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Tactical PositioningLong-term diversification has been the standard investment motto to enhance returns and reduce volatility. Sometimes, investors struggle to determine the appropriate asset mix based on changing objectives, market cycles, and correlations. Victor Zhou researched this dilemma, especially given recent challenges to the global 60% equity/40% bond portfolio amid a high inflation regime. The correlation between stocks and bonds remains elevated, US equity valuations appear stretched versus global equities, and commodities remain broadly under owned versus equities. Despite high uncertainty in the current market cycle, new trends may emerge, presenting both challenges and opportunities for diversified portfolios.
Victor's research showed that adding trend following to portfolio comprised of global equities (US, DM ex-US and EM), an active equity sector rotation sleeve, global bonds, and commodities is an agile alternative to the standard global 60/40 portfolio. The commodity sleeve is an important addition because of its ability to produce a roughly 8% annualized total return with lower volatility and a higher Sharpe Ratio (risk-adjusted return) versus a global 60/40 portfolio, according to research by AQR. We also noticed lower historical correlations between commodities and bonds, especially during times of inflation uncertainty. Commodities are also advantageous to balanced portfolios when economic growth surprises to the upside despite the potential for higher inflation. The trend following process is designed to allocate to each asset class segment when there is improving relative strength and momentum. Selections within each segment are made on a relative basis between holdings and versus the sleeve's benchmark. This process ensures optimal positioning without having to forecast economic regimes. Currently, the model remains overweight US equities with no allocation to bonds and commodities. This is because there is no shift in relative strength outside of US equities despite some signs of short-term improvement. To remove concentration risk in US equities, the model suggests an active allocation to a sector rotation strategy that provides a more equal-weight approach, albeit with a slight tilt to defensive sectors given seasonal volatility. Cross-Asset Correlations
Commodities could offer diversification benefits vs. stocks/bonds |
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Meet the Team
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Kyaw Swar
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Victor
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