Nicolas Rabener is a London based analyst who’s quietly developing a strong reputation for his ETF and factor-based analysis. He’s serving a valuable function for the growing army of buyers of quantitative funds who need to understand why one factor seems to work – and another doesn’t. Rabener also less frequently chimes in with more technical or macro based analysis which hits the spot for the modern, confused investor. His latest note – available HERE – at Factor Research looks at how investors (and financial commentators) mistakenly focus on just a single signal for divining the future direction of markets. His focus is on three closely related measures, namely volatility, dispersion and correlation. In simple terms, higher volatility & dispersion imply higher stock market risks but the relationship between correlation and risk is not linear. Crucially these market technicals “do not behave consistently across time”.
Starting with volatility, Raberner observes that commentators (me included) are quick to jump on news that volatility has jumped say, 20%, “until compared to the historical volatility of the index, where increases or decreases of similar magnitude were frequent. In recent years, higher stock market volatility was typically associated with falling stock prices and a potential harbinger of a stock market crash. However, in the years leading up to 2000, volatility was high and stock prices were increasing. The implications of changes in stock market technicals on returns and risks are complicated”. As the chart below clearly demonstrates.
Rabener also concludes that “stock dispersion is similar to volatility, but not the same. There are periods when stocks exhibit high dispersion, but not necessarily high volatility, e.g. when companies report earnings. Inversely, there are periods when dispersion is low, but volatility is high, e.g. during a market sell-off. However, most often dispersion and volatility are correlated. Daily dispersion, similar to volatility, exhibits a strong positive relationship to the probability of drawdowns.”
This analysis, Rabener suggests, highlights the fact market technical “do not behave consistently in bull and bear markets across time. Investors should, therefore, be cautious about using these on a stand-alone basis, although they might be more effective when combining them. Even more attractive is likely a combination with less related signals, e.g. trend following.”
All eyes on the monetary base
Technical analysis, of course, isn’t the only obsession of most financial commentators and investors – we also love focusing on big macro data sets. In particular, anything on central bank liquidity is increasingly seized on as a pointer for what might happen next with stock markets. Cross Border Capital produces some of the most interesting data in this field and their latest note contains yet another warning – that the global monetary base looks like it might be close to contracting.
According to the London based house, US domestic monetary base is currently contracting at a faster 11.4% 3m annualised rate and the US dollar monetary base shrinking by 4.1%. The chart below shows “the precipitous fall in liquidity provision since Spring 2017 (albeit with a brief respite during August last year)”. Other highlights of the report are that
- Foreign Holdings of Treasuries at the Federal Reserve are now growing at a noticeably slower 1.7% on a 3m annualised basis. (Growth is an indication of the monetisation of foreign flows.) This slowdown marks a return to the earlier trend, and breaks the
upward momentum seen in August
- Excess reserves (6-week moving average) are steadily decreasing and now stand at US$1.75tn (recent peak of US$2.25tn recorded in Sep 2017)
- Net liabilities due to foreign banks are falling, a sign that dollar liquidity in offshore markets is tightening
According to Cross-Border “US dollar monetary base is sometimes taken as a ‘crude’ proxy for Global Liquidity. It confirms what our more accurate monthly indicators have already shown”. Global liquidity might be tightening which could, in turn, warn of an imminent global slow down in growth.