Volatility is Nature
Ever since momentum was established as one of the premier market anomalies, investors have been trying to tame the beast of drawdowns that accompanies it. So far, all attempts have been like Vikram & Betal stories. Just when you think you’ve found something, the Market Gods laugh.
Broadly, the approaches have been:
Use stop-losses on every line-item. Works to escape sudden “macro” shocks but rakes up transaction costs during grinding markets. On a long-enough timeframe, returns are comparable to the monthly-rebalanced version.
Double-sort the top quintile of momentum for low-volatility. Makes intuitive sense but momentum stocks do what momentum do best: crash.
Use portfolio optimization on the top quintile of momentum to target the least possible portfolio volatility. Catnip for quants - after all, the whole should be greater the sum-of-parts. Doesn’t seem to work out in the wild.
Use market volatility to time momentum portfolios. Since volatility clusters, the minute it spikes, get out. The problem here is that you will only escape the big ones in 2008 and 2020, and that will skew your back-test. Similar to how the 200-day SMA escapes the Black Friday crash but goes long the next Monday close of the S&P 500, this strategy falls for the N=1 trap.
Momentum is known to trend. Can trend be your friend? Could work with midcap momentum but you could go years with this strategy underperforming buy & hold. We had a quick look here: Trending Momentum
With long-only momentum, I don’t think there’s a there there. The base strategy has some volatility characteristics that can be traded for transaction costs and time-shift underperformance but cannot be computed away.
Markets this Week
Hope springs eternal
Enhanced momentum strategies: compares the performance of three enhanced momentum strategies proposed in the literature: constant volatility-scaled momentum, constant semi-volatility-scaled momentum, and dynamic-scaled momentum. (sciencedirect)
Coordinated interest rate hikes are a wrecking ball.
Is this a long wave goodbye?
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How the U.S.-Chinese Technology War Is Changing the World (foreignpolicy)
How Washington chased Huawei out of Europe (politico)
U.S. bans Huawei, ZTE equipment sales, citing national security risk (reuters)
The Green revolution first needs a TCO revolution.
Shipping liquid hydrogen is not going to be a thing (thread)
Private equity sounds like a ticking timebomb.
Private equity may become a ‘pyramid scheme’, warns Danish pension fund (FT)
Collateralised fund obligations: how private equity securitised itself (FT)
When you are out to spend money, money will be spent.
A future without the flu can’t come fast enough.
We developed a new multivalent mRNA vaccine against all known influenza virus subtypes. (thread)
No one in the era of rationality was in favor of unavoidable human pain. So, when the entire human race decided that the complications caused by lust weren’t, in the end, worth it, they concluded that people would live much more calmly and pleasantly in a society where sexual competition was absent. It soon became clear that humans would be better off if everyone simply stopped reproducing.
The End, Emanuel Derman