Volatility is Nature

not Nurture

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:

1. 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.

black: no stop-loss, monthly rebalance; red: trailing-stop-loss, daily rebalance

2. Double-sort the top quintile of momentum for low-volatility. Makes intuitive sense but momentum stocks do what momentum do best: crash.

black: double-sorted, monthly rebalance; red: momentum only, monthly rebalance

3. 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.¹

4. 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. ²

5. 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

Links

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.

Philipp Heimberger @heimbergecon

OECD finds that when all central banks hike interest rates simultaneously, the impact on GDP is *larger* (more negative) but the impact on inflation is *smaller* (i.e. inflation responds less to the hikes because the foreign exchange channel is muted). Countries then hike more.

~

Is this a long wave goodbye?

U.S.-Europe Trade Booms as Old Allies Draw Closer (WSJ)

US, EU Aim to Hit Back at Non-Market Policies With Eye on China (bloomberg)

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)

Javier Blas @JavierBlas

OIL MARKET: Washington eases its oil sanctions on Venezuela, allowing Chevron (for the next 6 months) to pump crude in the Latin American nation and export it into the United States. A major shift in the White House policy | #OOTT #Venezuela $CVX 🇻🇪 ⛽️ 🇺🇸

Science Is Strategic @scienceisstrat1

EVs are now an astonishing 25-30% of all new car sales in Europe and China Cc: @JesseJenkins @Noahpinion @FutureJurvetson @dwallacewells

Stephane Deo @StephaneDeo

Super interesting paper by IFO: 75% of companies have reduced their natural gas consumption without cutting production. This explains the resilience of activity so far. ifo.de/en/press-relea…

~

Private equity sounds like a ticking timebomb.

Private equity may become a ‘pyramid scheme’, warns Danish pension fund (FT)

Kuppy @hkuppy

1)Every cycle has a place where fraud congregates. I am convinced that the mark-to-fantasy world of PE/VC is where the fraud is this cycle. Many of these funds are levered, hence taking massive losses, yet showing their LPs big gains b/c they can make up the marks. Look below👇

Collateralised fund obligations: how private equity securitised itself (FT)

~

When you are out to spend money, money will be spent.

Bismarck Analysis @bismarckanlys

China and Saudi Arabia have similar problems. The Saudi Crown Prince is trying to invest his way into industrializing Saudi Arabia. China is trying to invest its way into industrializing Pakistan. Both plans are failing. You cannot buy industrialization with money.

Bismarck Analysis @bismarckanlys

Masayoshi Son poured $150 billion into the global tech industry. After 5 years, there isn’t one clear example of a tech innovation that would not exist if that money had not been spent. The money just failed to drive innovation. Read the Brief here:

brief.bismarckanalysis.comMasayoshi Son Reveals the Limits of Money in TechThe charismatic SoftBank founder is arguably the single best fundraiser in the world. But more money is not enough to deliver on expectations of economic growth and innovation.

~

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

Meme of the Week

RedditCFB @RedditCFB

Never forget that England blew a 13-colony lead. 🇺🇸🇺🇸🇺🇸

1. Low Volatility: Stock vs. Portfolio

2. VIX and Equity Index Returns, Part I & Part II

Volatility and Returns of Momentum Indices

Reducing Crash Risk in the Nifty Alpha Indices