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Executive Summary
January 2025 |
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. 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. Therefore, we recognize the importance of adapting strategies to various market environments. 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. 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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Combo Models
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Trend & MomentumThe MACD/RSI model, developed by Kyaw Swar Ye Myint, attempts to measure renewed price strength within the direction of the prevailing trend. But continuous price rises and falls do not last forever. Over time, price trends may become extended and experience a reversal. Z-scores can be used to measure price deviations from the historical average.
Opportunities may appear as price action sifts away from extremes with increasing momentum, measured by the Z-score and MACD/RSI. 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. Kyaw’s MACD/BB model is a recent enhancement to our trend following process. The model relies on the nature of Bollinger Bands to assess market volatility and trend strength, while the MACD confirms momentum shifts, enhancing signal reliability. When these two studies are used together, they give a clearer picture of market conditions. For example, if the Bollinger Band shows that prices are moving strongly in one direction and the MACD agrees, this may suggest a continuation of the prevailing trend. We found this combination to be reliable based on historical price data across major equities, commodities, and currencies. Equities: Global equity markets experienced notable shifts in the fourth quarter, highlighted by contrasting z-score movements (quarterly price close relative to the 10-year average) . The S&P 500 saw its z-score decrease from 2.41 to 1.9, indicating a slowdown in upward momentum, though it remains strong compared to historical averages. Conversely, the China CSI 300 Index showed significant improvement, with its z-score rising from -1.24 to -0.17, suggesting a recovery from previously low levels, and the possible formation of an uptrend. FTSE 100, initially marked for a buy in mid-2024, has been downgraded to a hold since October 2024. The downgrade coincided with a fall in its z-score from 1.91 to 1.6, indicating a reduction in bullish momentum. However, UK equities are consolidating within an uptrend, which could offer potential value opportunities if momentum improves. The Nikkei 225 in Japan, maintained its relatively high z-score, which could signal overbought conditions. The chart below compares long-term generic momentum scores with respective z-scores: China/Hong-Kong equities remain oversold with strong momentum, while Brazil has a more balanced z-score with negative momentum. We also applied a quality screen (quantitative momentum "Q-MOM") to test for continuous or discrete momentum. Continuous momentum implies a large number of small positive returns over the past 12 months (smaller value is ideal). Based on the quality screen, China, Hong Kong, and Brazil do not offer sustainable momentum, and should be reserved for tactical positioning. So far, their high generic momentum scores are the result of short-term positive price swings. Elsewhere, US equities appear stretched, while European equities have a more balanced momentum and z-score ranking. 
Fixed Income:
The fixed income sector saw mixed outcomes with some bond indices showing improvements while others declined. The US Aggregate Bond Index saw its z-score decrease further into negative territory from -1.04 to -1.49, reflecting increased bearish sentiment. In contrast, the iShares iBoxx $ High Yield Corporate Bond ETF shifted dramatically into positive territory, going from a z-score of -0.66 to 0.89, which reflects a positive backdrop for high-yield debt, albeit stretched relative to other fixed income segments. This is consistent with tighter credit spreads, which means that investors have been willing to accept a lower yield for taking on additional risk in corporate bonds relative to the stability of Treasury bonds. Treasury bonds, particularly long duration, remain oversold with relatively high starting yields. For more cautious investors, bonds could offer a total return buffer compared to the higher volatility (and higher starting valuation) of equities. For investors with greater appetite for risk, negative momentum signals continue to favor equities over bonds. Commodities: Commodity markets displayed varied trends; Cocoa Futures saw a significant z-score decrease from 4.01 to 2.94, though they still maintain a strong uptrend. Natural Gas Futures notably reversed from a negative z-score of -0.76 to a positive 0.77, suggesting a bullish sentiment shift possibly driven by seasonal demand factors. Uptrends in Copper Futures and Gold Futures have consolidated with their z-scores decreasing to 0.99 and 2.11, respectively. Currencies: The US Dollar Index registered an increase in its z-score from 0.63 to 1.84 with positive momentum signals. Conversely, the Euro and GBP saw their z-scores deteriorate against the USD, moving towards more negative values, which might indicate longer-term bearish trends against a strengthening dollar. Our quantitative scores remain favorable for the dollar and, for now, do not show any long-term positives for momentum and value combinations outside of the US. ___ As we enter 2025, equities are showing a mix of slowing momentum with nearly all signals on “hold.” Fixed income markets provided mixed signals with a preference for high-yield, while the downtrend in Treasuries appears increasingly oversold relative to its long-term average. This reflects a consistent risk-on environment, which may begin to wane as new trends emerge in undervalued defensive assets. Commodities remain a source of diversification relative to equities and bonds. Oversold opportunities have emerged in energy markets, while there is a wide dispersion of returns across the commodity complex. |
Price Dispersion
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Variability of recent quarterly price action relative to the 10-year average price level, ranked by asset. Price ratios demonstrate the strength of one asset versus another, ranked by their deviation from a relative mean.
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Z-score Ranking
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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. Recent positioning: Currently, the model remains overweight US equities with no allocation to fixed income. This is because there is no shift in relative strength in bonds versus equities. 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, especially given relative weakness in tech mega-caps. A slight tilt toward international markets was made in Q4 2024 which aligned with positive momentum signals in some markets outside of the US. Within commodities, only gold has shown promise in terms of relative strength and momentum. The model suggested an allocation tilt toward gold, funded by a reduction in international equities. The tactical gold position may provide additional relative strength versus the global fixed income benchmark as correlations decline. Generally, a rotation from risk assets to defensive assets would warrant diversification into gold and eventually long-duration Treasuries. The slight defensive tilt, however, is more cyclical in nature based on the portfolio's overweight to energy and materials relative to the global 60/40 benchmark. This results in an inflation hedge while narrowing the overall equity overweight. Correlations between Gold, Stocks, Bonds
Gold's correlation with stocks remains elevated, but ticked lower since Nov. '24 while the stock/bond correlation rose. Gold could offer diversification. Correlations between Gold, Bonds
...and gold's correlation with bonds is starting to fade. |
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Meet the Team
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Kyaw Swar
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Victor
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