“… whenever energy is transformed, into a useful form, it also produces “useless” energy as a degraded by-product: unintended consequences...”
For those of you who celebrate Christmas, we here at Hedgeye hope you had a blessed day off with your family. There’s a lot of stress permeating throughout our industry associated with the first US equity bear market in nearly a decade, so I’m sure it was nice to get away from your screens – if only for a few hours while your kids unwrapped their presents.
I’d also like to take this opportunity to thank those of you who’ve contributed to a Merry Christmas for people other than your immediate family. A large proportion of the people in and around your community don’t have the financial means to experience the joy and fellowship that Christmas provides for so many. I grew up as one of those individuals.
“We used to fuss when the landlord dissed us/
No heat, wonder why Christmas missed us/
Birthdays was the worst days/
Now we sip Champagne when we thirsty”
-Notorious B.I.G. on “Juicy”
Now, thanks to the work of our 501(c)(3) Hedgeye Cares and our partnership with fantastic organizations like Domus Kids and Bridgeport Caribe Youth Leaders, we’re making sure Christmas misses a few less families in and around our community each year. For those of you who missed the opportunity to help out this holiday season, but would like to join our outreach efforts, we’ll be hosting our 4th annual Golf Fundraiser in May. If you enjoy swinging the sticks, come swing them for a great and growing cause (contact form HERE).
Back to the Global Macro Grind…
What are the “unintended consequences” of the following market thermodynamics (presented in no particular order)?:
- “Index funds now make up almost 20% of assets in mutual funds. More money in cheaper, passive funds lowered the average fee paid for both active and passive mutual funds. According to a report from Morningstar, the average management fee fell almost 45% since 1996.” (SOURCE)
- “… passive funds now own an average of 17% of each component of the S&P 500, per Goldman’s data (the range is as little as 10%, and as much as 35%), whereas passive ownership was “a rounding error” a decade ago.” (SOURCE)
- “The investment bank calculated that for the average S&P 500 company, the share of its stock that might trade on fundamental views has dropped to 77% compared with 95% a decade ago.” (SOURCE)
It’s hard to “know” for sure, but I reckon that:
- Liquidity continues to deteriorate;
- Price dislocations happen more frequently; and
- Said dislocations appear to be more persistent.
None of that is ideal for active managers who rely on each other’s wit to help their own fund(s) outperform the market (e.g. “stock market = beauty contest”).
Don’t take my word for it, however. According to Acadian Asset Management – a $96 billion quant firm based in Boston:
“… the ability of “momentum” to deliver strong returns deteriorated by 43 percent in developed markets between January 1998 and March 2018. Over the same period, “growth” saw a 10 percent deterioration in the factor's ability to produce excess returns while “quality” showed a 12 percent decline in alpha efficacy and “value” had an 11 percent drop.” (SOURCE)
Acadian goes on further to suggest that these results are consistent with the view that the rise of passive investing is effectively “dumbing down” markets in the way that makes it harder for active managers to generate excess returns, which is precisely what we’re seeing in the data:
- “Only about seven percent of the 550 domestic equity funds in the top quartile at the end of September 2016 remained there two years later, S&P Global said in a research report released Tuesday. Actively managed funds fared even worse trying to keep their status over a longer stretch of time… Only 1.43 percent of all domestic mutual funds investing in stocks were persistent top performers for five straight through September 2018, the report shows.” (SOURCE)
- “Only 33% of large-cap core, growth and value mutual funds have outpaced their benchmarks this year compared with 45% in 2017 and an average of 37% during the past 10 years, according to the Goldman analysts… In terms of gains and losses, only the average large-cap growth fund made money year to date while the average large-cap value and small-cap core funds lost money, and all three categories have underperformed their benchmark indexes.” (SOURCE)
Consider the following asset gathering entropy as well:
“BlackRock estimates that there are $1.9tn of assets in dedicated factor strategies and predicts this will swell to $3.4tn by 2022.” (SOURCE)
Obviously, quant behemoths AQR and RenTech are included in that calculus. It’s unclear, however, whether or not BlackRock includes the $100-200 billion in AUM at multi-manager, largely market-neutral (or some version of that) hedge funds in their calculus given their daily need to delta hedge factor exposure risk.
Regardless, we are all aware of the large quantity of leverage such strategies employ and how their decisions to gross up/down sectors and style factors contributes to market volatility – the same volatility you’ve seen on your screen throughout this #Quad4 “hurricane”.
All told, the primary reason I wanted to discuss the drivers of changing market dynamics was to alert investors to the many ways in which The Machine is becoming an ever-increasing driver of financial market returns. The speed, persistence, and intensity with which Mr. Market prices in our GIP Model Quadrant regime shifts at the asset class, sector, and style factor level appears is increasing at an accelerating rate.
It’s been humbling to watch, but also terrifying at the same time. We’re going to have to work that much harder in 2019 to make sure we help your firm continue to stay out in front of such phase transitions.
For those of you who are paying clients, I wanted to personally thank you for your continued support; the team and I appreciate you for respecting the fact that our hard work should command a fee commensurate with the passion and performance we deliver to you each year.
For those of you who are not yet paying clients (or at an asset manager currently hiding behind the MiFID II free lunch veil), just know that we’re here to serve you too. Whenever you’re ready, please let us know how we can help. I’m just a small-town American Capitalist that wants to grow my business and support my family by helping you grow and support yours.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.70-2.92% (bearish)
SPX 2 (bearish)
RUT 1 (bearish)
NASDAQ 6103-6701 (bearish)
Utilities (XLU) 51.00-57.40 (bullish)
Consumer Staples (XLP) 48.11-52.18 (bearish)
REITS (VNQ) 71.25-81.90 (bullish)
Industrials (XLI) 59.20-64.99 (bearish)
AAPL 144.68-162.10 (bearish)
AMZN 1 (bearish)
FB 120-137 (bearish)
NFLX 228-263 (bearish)
TSLA 282-339 (bearish)
VIX 19.63-37.30 (bullish)
USD 95.59-97.50 (bullish)
Oil (WTI) 41.86-48.31 (bearish)
Nat Gas 3.29-4.23 (neutral)
Gold 1 (bullish)
Keep your head on a swivel,