With the Federal Reserve (Fed) effectively flagging that a rate cut is imminent, markets are preparing for a policy shift at the next meeting in two weeks’ time. Our own analysis shows today’s economic landscape mirrors that of July 2019, when the Fed lowered borrowing costs for the first time since the Great Financial Crisis.
During periods when macro factors become key drivers of market returns, we turn to our proprietary macro timing models to better understand the backdrop.
Our MacroScope model analyses historical market regimes to provide insights into future behaviour by comparing risk factors and sectors. Additionally, our Supervised MacroScope model incorporates human labelling of macroeconomic time series – effectively a regression model – to highlight the strongest relationships between macro variables and forward stock returns.
We ran our model on August 27, after Fed Chairman Jerome Powell reinforced expectations for a rate cut in September. The MacroScope identified mid-2019 as the most similar period to the current environment, followed by mid-2020, when the world grappled with the pandemic, and mid-1995 when the Fed cut rates after a series of hikes the previous year.
Comparing 2019 and now
In mid-2019, the Fed was concerned the escalation of a US-China trade war would harm the economy and push up unemployment rates. Against this backdrop, the Fed eased rates midway through an otherwise healthy business cycle. Similarly, the current environment is characterised by expectations of further monetary easing from the major central banks (except Japan), albeit for different reasons. This time, the motivation is primarily to counteract an economic slowdown, weakening job growth and to manage inflation expectations.
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What does this mean for style factor positioning in a portfolio?
From a style factor positioning perspective, i.e. how different investment styles such as Momentum, Value and Growth are weighted in a portfolio, the two models complement each other by taking very different stances amid rapid market inflections.
Figure 2 shows how the MacroScope model has maintained a pro-Momentum stance, further increasing its bet on Momentum since mid July, despite the factor’s recent struggles. This approach underscores our belief in the persistence of certain market trends, even amidst broader volatility. Conversely, the model advocates going short on Low Volatility (Residual Volatility), moving away from the usual areas of safety in volatile markets, and also shorting Liquidity.
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In contrast, the Supervised MacroScope model has significantly shifted from pro-Momentum to anti-Momentum, a move that proved both timely and opportune. By taking a more defensive stance, the Supervised MacroScope model has aimed to mitigate some of the downside risks associated with the recent market turmoil.
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By combining various different signals in an alpha modelling process, investors benefit from the diversification effect that arises from the interaction between signals.
What about industry positioning?
Within industries, the most notable change is the model's less favourable view of semiconductors and semiconductor equipment, aligning with the recent market rotation out of artificial-intelligence-related stocks. This shift reflects a broader market sentiment that has become more cautious towards high-growth, high-valuation sectors amidst rising volatility.
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Conversely, the model has continued to recommend short-selling commodity industries such as gold, metals, and minerals, reflecting a weakening economic backdrop. This positioning suggests that while inflation concerns persist, the overall economic outlook remains tepid, reducing the attractiveness of commodities as a hedge against inflation.
Conclusion: Leveraging historical context
Today's market parallels with mid-2019 offer strong clues for opportunities to navigate economic headwinds. With the August market rout behind us and a Fed policy shift imminent, it shows how investors must remain adaptable to moving macroeconomic signals and sector rotations.
All data Bloomberg unless otherwise stated.
With contributions by Valerie Xiang, Associate Portfolio Manager at Man Numeric in Boston.
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