One year ago, the prospect of a bear market in the U.S. stock market appeared significant, as indicated by a Hidden Markov model (HMM). This cautionary message, highlighted in previous discussions (see here, for example), has had a mixed track record. While stocks experienced a downturn in late 2015 and early 2016, the extent of the S&P 500’s decline was fairly limited. Although hindsight makes this observation clear, the outlook at that time was fraught with uncertainty. Now, the HMM signal has shifted to bullish for the first time since mid-August 2015. After a practical evaluation of the model over the past year, it’s valuable to reflect on what we have learned about using the HMM to assess bear-market risk.
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The landscape is saturated with backtests claiming to unveil new portfolio strategies that promise enhanced risk management and improved returns. However, a critical stress test often remains absent, calling into question whether these favorable results are genuine or mere statistical coincidences. While analyzing a single historical run may seem promising, advancing the backtest by simulating results across various scenarios forms a more reliable foundation for assessing future performance. Unsurprisingly, only a small fraction of strategies that appear favorable on paper can withstand this rigorous standard. This poses a challenge for those keen on producing optimistic research reports hinting at potential financial successes. For investors hesitant to commit real capital to largely untested strategies, stress testing becomes essential for distinguishing viable options from less promising ones.
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The unexpected decline in the ISM Non-Manufacturing Index for August has sparked fresh concerns regarding a potential weakening of the US economy as it approaches the end of 2016. Compounding these worries, the Federal Reserve’s broad Labor Market Conditions Index (LMCI) dropped into negative territory last month. Although these soft data points do not directly indicate an impending recession, they certainly cast doubt on the appropriateness of raising interest rates at the upcoming Fed meeting scheduled for September 20-21.
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Recent hawkish comments from Federal Reserve officials have fueled speculation about another potential interest rate increase. However, the recently retired governor of India’s central bank warns that the landscape of low and negative interest rates, entrenched in global monetary policies since 2008, will not be easily reversed. “Often when monetary policy is really easy, it becomes the policy of choice,” Raghuram Rajan told The New York Times.
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Last week, emerging-market equities surged ahead in the competitive landscape of major asset classes, as indicated by various proxy ETFs. This segment of global stocks has seen weekly gains in seven out of the last eight weeks. In contrast, a broad spectrum of commodities led the decline last week, as ongoing negative momentum continues to impact raw material prices.
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● Progress: Ten Reasons to Look Forward to the Future
By Johan Norberg
Review via The Economist
Humans tend to be pessimistic, with around 71% of Britons believing that the world is worsening and only 5% perceiving improvement. When asked whether global poverty had decreased significantly over the last two decades, only 5% of Americans answered correctly, confirming it had actually been halved. Johan Norberg, a Swedish economic historian and the author of the book “Progress,” highlights that this pervasive negativity isn’t mere ignorance, as even random guessing would yield a more accurate answer.
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According to a report from the Labor Department, U.S. job growth decelerated in August, although the year-over-year growth rate remained steady at 1.90%. Economists had anticipated that U.S. companies would add 179,000 jobs last month; however, the actual increase was significantly lower, at 126,000.
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Correction: The table below displaying expected versus trailing risk premia was initially posted without the data for Foreign REITs/Real Estate. This oversight has been rectified, and a revised version of the table, now including all data, is available. We apologize for the error.
–JP
The Global Market Index’s expected risk premium fell slightly in August after reaching a 14-month peak the previous month. The GMI—an unmanaged market-capitalization-weighted mix of the major asset classes—is projected to yield an annualized 3.6% risk premium over the long term, which is slightly below last month’s estimate. (For details on the equilibrium-based methodology used to generate these monthly forecasts, please refer to the summary below.)
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In August, inflation-linked bonds issued by foreign governments demonstrated remarkable performance, leading among major asset classes. The impressive 3.6% total return for the Citi World Inflation-Linked Bond ex-US Index in the last month suggests rising concerns regarding potential pricing pressures on the global economy. This perception might be overblown, as disinflation and negative interest rates continue to overshadow various key regions across the globe.
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The ADP Employment Report indicates that U.S. private-sector payrolls rose by a moderate 177,000 in August. Although this increase falls short of July’s revised gain of 194,000, it remains robust enough to support the notion that the U.S. economy is poised for stronger growth in the third quarter, potentially recovering from the stagnation experienced in the first half of the year.
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