A new report from RCM Alternatives highlights that managed futures and global macro funds are still waiting for a market correction that may or may not appear in 2020.
The report, Managed Futures Outlook 2020 The Waiting Game, notes that these funds have now been waiting 10 years for the next crisis in global markets, for a meaningful increase in cross asset class volatility or follow through on directional moves in assets aside from the S&P 500. It is when one or more of these occur that these funds typically perform their best.
Regarding the current state of global financial markets, RCM Alternatives cites a quote from Bridgewater founder, Ray Dalio, which states: “This set of circumstances is unsustainable and certainly can no longer be pushed….[which] is why I believe that the world is approaching a big paradigm shift”.
The report then goes on to argue that the key word in this quote is “approaching”.
“This quote was said in late 2019, but could have easily been said by any number of billionaire hedge fund managers (or even lowly centi-millionaires) at any time over the past decade. The train has always been approaching, and by definition is closer to arriving today than it was yesterday. But that doesn’t mean we’re done waiting,” it says in the report, which was written by Jeff Malec, managing director and partner at RCM Alternatives.
Noting that a number of major financial services firms are predicting a market correction in their 2020 outlooks, the report suggests that this is actually a result of a feedback loop created when investors tell these financial institutions that they’re concerned that the 10-year rally in stocks won’t prove sustainable and then these financial institutions produce research reports emphasising these concerns to investors.
Source: RCM Alternatives
But, just because lots of investors expect an equities market correction, it doesn’t necessarily follow that there will be one.
In the report, Malec says that “while you can put chart after chart up showing a correction is likely because of this problem or that in the economy, the main consensus appears to be that we’re just sort of due for a correction. US stocks hit new all–time highs again here in December as we’re writing this, extending what was already the longest bull market run, like ever, in US stocks without a 20% correction. We’re at nearly 11 years, and some 400% higher since the last one.”
He adds: “But saying this longest ever bull market has to end because it’s the longest ever seems like either wishful thinking or circular logic, or both. Maybe it’s the longest ever because it has a unique mix of factors that preclude it from having a correction? Maybe the financial industrial complex of Wall Street, asset managers, and central banks has gotten so good at dampening volatility and aiming for higher asset prices, torpedoes be damned, that this is the…wait for it…new normal?”
The obvious question following on from these musings is: what does the uncertainty regarding a market correction mean for managed futures and global macro funds? RCM Alternatives argues that these funds won’t change their approach as a result of this uncertainty, except to perhaps use more machine learning and AI to help their strategies.
“They’ll analyse prices in all sorts of markets and get into tons of moves, some false, and some true breakouts. Some on a very short day–to–day basis. Some on a much longer month-to-month basis. They’ll look for some sort of catalyst to awaken volatility, and be there in a market crisis if it happens because of that willingness to participate in all the false breakouts lower,” says Malec in the report.
However, a rather large caveat is then added to this point. The report, citing a Profit & Loss article published in November, expresses concern that some managed futures funds have been pivoting away from their classic return profile because “most firms would change their spots rather than go out of business waiting for vol and trends to return”. Further, it presents some data which seems to lend credence to this concern because it shows that managed futures funds have been adding more long exposure to equities and have increasingly been favouring slow trend instead of fast trend factors.
What this means, claims RCM Alternatives, is that an extended sell-off in equities would cause a bit more short-term pain for managed futures funds than it would have in the past as these funds would be slower to exit the longs and enter the shorts because of their slow trend exposure and also they would have more long equity positions in the first place.
“This is all, on the average, and not directly tied to any one program, of course. But the leopard’s spots should be watched closely in the next crisis,” notes Malec.
Given that no one can really say with any uncertainty whether there will be a significant correction in global equities, he concludes: “For our two cents, we’ll continue to look for dynamic investment strategies that react to paradigm shifts and get on board with them. Things that do well in volatility spikes, but also when the spikes don’t happen…Antifragile alternative investments that spread risk across multiple long volatility return paths – not just the classic trend following approach, which is rather path dependent on an extended directional move and cross asset correlations.”
It is worth pointing out that, even in the absence of the optimal market conditions for managed futures funds, the Societe Generale CTA Index is up 6.25% for the year. However, Malec makes it clear in the report that this is mainly due to moves in the global bond market.
“Bonds, though, against all the prognostications of higher interest rates – shot lower for the year in just the sort of continued directional move trend following type models crave…While the 10 Year Treasury Rate fell from a high of 2.79% to a low of 1.47%, managed futures as measured by the SocGen CTA Index made hay…earning nearly 12% between the day after the first print below 2.50% (3/25/19 – a rough proxy for when CTAs may have been getting short rates/long the bond prices) and the low of 1.47% on 9/3/19,” he says in the report.