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“In some places we’re picking up disciplined risk premiums.”

-Cliff Asness

While it’s easy to rib my friends at Barron’s sometimes (on cover stories about “No recession – we’re going back to 3% GDP”, for example), I try to give credit where it’s due and I applaud their headline story this weekend about one of the asset managers I respect most – AQR.

I cited a fantastic interview AQR’s founder, Cliff Asness, did in an excellent markets book I’ve been reviewing for Early Look readers titled Efficiently Inefficient, by Heje Lasse Pederson. The aforementioned quote was part of an important answer Asness gave on AQR’s strategy:

“I think in some places we’re picking up disciplined risk premiums that are not very correlated with long-only markets, which means, if someone doesn’t have those in their portfolios, they should add them. In other places I think we’re taking advantage of human biases and we’re trying to be disciplined and determined about it, taking the other side of some common psychological trait or institutional constraint…” (pg 164)

Back to the Global Macro Grind

Just to boil this down, a “risk premium” is a return that’s greater than whatever you’d call the “risk free” rate. For us, it’s what we get paid for understanding the prevailing growth and inflation environment and having the right “risk” allocations associated with that.

What most people miss is how the rate of change of growth and inflation is affecting market expectations. That’s why there is a lot of “excess return” to be made in front-running where asset allocators have to, as Asness points out, “add to their portfolios.”

Sure, a big shot endowment man might start with what he “needs” as a return, but if the risk free rate is a negative yield and illiquid assets are deflating, then the risk premium is in owning style factors like liquidity, “low-beta” and, of course, Long-Term Treasury Bonds.

Disciplined Risk Premiums - GDP cartoon 02.29.2016

In other words, as US growth slowed from 3% to 2% to 1% (from its cycle-peak of 3% in 1H of 2015):

  1. Long-term Treasury Bond exposures like TLT have earned a risk premium of +8.4% YTD
  2. Utilities (XLU) have earned a risk premium of +7.0% YTD
  3. If you ran a hedge fund that is only long Utes (XLU) and short Financials (XLF), you’re +18.5% YTD

Oh, and that would probably be called a boring hedge fund that isn’t putting “leverage” on that pristine risk premium associated with the basic understanding that rates fall (they don’t “hike”) during #GrowthSlowing (XLU +7% YTD vs XLF -11.5% YTD).

To be fair, no reasonable risk manager would put their entire fund in one LIQUID non-consensus position like XLU vs. XLF (see Ackman’s ILLIQUID consensus Valeant (VRX) “pick” for details), but there would be one heck of a story on the cover of Barron’s if someone did!

I’m obviously generalizing here. I’m well aware that the +8.4% and +7.0% (and +18.5%) returns do NOT include interest and/or dividend payments. In the hedgie format they don’t SUBTRACT fees. And, of course, I am using a “risk free rate” of 0%.


Well, we can be like every other consensus talking head and yap about Trump, China, or Oil today. Or we can just get back to work and A) protect the risk premium we’ve earned YTD (Rule #1 = Don’t Lose Money) and then B) build upon that (compounding returns is cool).

Let’s start with the TAIL risk wagging the disciplined dog here – corporate profits:

  1. Earnings Season is coming to an end – 485/500 companies in the S&P have reported
  2. Aggregate SALES are -4.5% year-over-year and EPS (non GAAP in some cases) are -8.5% year-over-year
  3. Only 3 of 10 S&P Sectors had POSITIVE year-over-year EPS growth
  4. Ex-Telecom (don’t do that Mucker!) Healthcare and Consumer Discretionary EPS growth closed the quarter on the lows
  5. Financials finished Earnings Season with NEGATIVE EPS growth of -5.9% year-over-year

Not to simplify the complex, but if 3-6 months ago the cover of the WSJ walked through that a #LateCycle rate hike would perpetuate a stock market decline via “down earnings” for non-Energy Financials via Yield Spread compression, would people have listened?

Moreover, people are starting to remember that there is what Soros calls “reflexivity” (Asness calls it a “common psychological trait”) associated with stock market declines.

For #behavioral evidence of that reality, look no further than one of our better new short selling ideas – US Housing (ITB). Signed contract activity for “Pending Home Sales” contracted another -2.5% sequentially in January. That’s a 17 month low in rate of change terms…

And, yes, like early cyclicals (Industrials, Energy, etc.) now this #LateCycle consumption and employment factor (Housing Demand is linked to both) has slowed to NEGATIVE -1.4% year-over-year. For Housing Bulls (we were The Bull on Housing for most of last year) #NotGood.

Neither is being invested on the same side as the crowd (at the turn) when the economic, profit, and credit cycles are rolling off their cycle-peaks. But you already know that. Welcome to March. Let’s get out there and compound some risk premiums!

Our immediate-term Global Macro Risk Ranges are now:

UST 10yr Yield 1.65-1.81%



VIX 18.54-26.50
USD 96.43-98.63
Oil (WTI) 28.48-34.75

Best of luck out there today,


Keith R. McCullough
Chief Executive Officer

Disciplined Risk Premiums - 03.01.16 Chart