A paper by Greenwald, Lettau, and Ludvigson argues that short-term (quarterly) equity price fluctuation arise mainly from changes in risk aversion, while long-term trends (over decades) are heavily influenced by reallocation from labor to capital income. The latter appears to explain all the stock market gains in the U.S. since 1980.
Assessing the risk of equity market “crashes”, academic work has focused on price-earnings ratios and bond-stock earnings yield differentials. A recent paper by Lleo and Ziemba provides theoretical reasoning and empirical support for these warning signs.
As risk perceptions and risk aversion are fluctuating overtime, so should equity premia. This is a basis for the predictability of equity returns, even in an efficient market. A new Bank of England paper provides evidence that equity returns are indeed predictable by using two classical frameworks: the dividend discount model and multi-indicator vector autoregression.
A new McKinsey report estimates that total debt of households, corporates, and governments has expanded 40% since 2007, reaching a total of 286% of GDP last year. Government debt ratios will be hard to contain through fiscal tightening and economic growth alone. China’s non-financial debt has quadrupled, with credit quality critically dependent on the real estate sector.
The ECB now runs one of the most complex monetary policy regimes. Beyond regular liquidity supply, its operating framework features long-term full-allotment refinancing operations, generous collateral acceptance, and a commitment to conditional open-ended interventions in sovereign markets. Subsequently, it has adopted or expanded forward guidance, targeted lending and large-scale outright asset purchases.
Exchange rates are pulled about by countless factors. There is a tendency to focus on standard fundamentals that happened to coincide with recent exchange rate moves. This has given rise to the “scapegoat theory of exchange rates”. It is nicely explained in a recent Bank of Italy paper. It implies caution in respect to popular “FX themes” in broker research that may lead to distortions, crowded positions and setback risk.
A new BIS paper illustrates how debt and collateralization create liquidity. In particular, money markets rely on excessive and obfuscated debt collateral to contain information costs. Opacity and “symmetric ignorance” support their smooth functioning. The flipside is that large negative shocks to collateral values inevitably catch markets “uninformed”, disrupting liquidity services.
Simple regression is inadequate for predicting bond returns, as the character of rates markets changes fundamentally with economic conditions. In financial modelling terms this calls for time-varying parameters, time-varying volatility, and model uncertainty. A CEPR paper claims that these features can help turning standard forecast factors (forward rates, forward spreads, and macro) into a valuable prediction model.
The ECB 2015/16 asset purchase program will include sovereign and quasi sovereign debt, ABS, and covered bonds. The envisaged annualized pace of balance sheet expansion should be around 6% of GDP. Pace and size are conditional on inflation expectations and open-ended, subject to restrictions on market size and issuer quality. The absence of full loss sharing could limit benefits for sovereign credit risk.
A BIS paper shows significant positive correlation of implied FX volatility and local EM bond yields. Empirically the causality runs mostly from FX to bonds, probably because currency risk is a key factor of foreign bond holdings. However, there can also be reverse causality, when FX derivatives are used as proxy hedge in a bond market turmoil. Since FX volatility is stationary, extreme values can indicate value in local EM bonds.
Macrosynergy is a London based macroeconomic research and technology company whose founders have developed and employed macro quantamental investment strategies in liquid, tradable asset classes, across many markets and for a variety of different factors to generate competitive, uncorrelated investment returns for institutional investors for two decades. Our quantitative-fundamental (quantamental) computing system tracks a broad range of real-time macroeconomic trends in developed and emerging countries, transforming them into macro systematic quantamental investment strategies. In June 2020 Macrosynergy and J.P. Morgan started a collaboration to scale the quantamental system and to popularize tradable economics across financial markets.
