Saturday, November 28, 2020

Public pension funds -There are no quick fixes

The National Conference on Public Employee Retirement Systems (NCPERS) produced a paper, "Ten Ways to Close Public Pension Funding Gaps" which tries to provide some solutions to the problem with public pension shortfalls. All have some merit, but all fall short of the real problem. More money, lots of it, has to be raised or benefits, lots of them, will have to be sacrificed. Without clear specifics for each proposal, it is hard to see how much of the funding gaps will be closed. For those public pensions that are close to full funding any of these choices may be enough to solve any small gap. For those that have significant gaps, the policy proposals will not solve the problem.

The choices:

Leverage and liquify - Borrow money to support pensions or liquify existing assets  

  • Pension obligation bonds 
  • Action of the Fed - For example, buying municipal bonds to allow leverage and liquidity 
  • Bridge loans 
  • Securitizing public assets - liquify public assets to pay for benefits
Structural changes - target payments to pensions, obtain scale, target contribution adjustments, increase taxes 
  • Dedicated revenue streams 
  • Stabilization funds 
  • Monthly employer contributions 
  • Plan consolidations
  • Auto triggers to adjust contributions 
  • Reforming revenue and increased taxes 
Why is this a global macro problem? The dynamics of pension will lead to long-term macro drags that cannot be easily solved by monetary policy or federal fiscal policy. If inflation increases or valuations decline, the impact on pay-outs will be real. Any inflation adjustment will not close the funding gap. Lower expected returns will only increase the gap. This is a problem that will have to be addressed by the new US president.

Friday, November 27, 2020

Momentum is everywhere - can even be found intraday


Momentum is everywhere, in every market sector, and for all timeframes. It can even be found across weeks, months, and intraday. The behavioral reasons for momentum transcend all markets. There are also structural reasons based on the hedging behavior of traders that will also drive momentum. This does not mean that momentum will work at all time and in all markets, but the odds are in your favor.

A new paper "Hedging demand and market intraday momentum" focuses on intraday momentum that is based on the hedging demand of traders that have to rebalance their risk exposures. There has been a strong view that momentum is a behavioral issue. Investors have a slow reaction to news. However, there also is momentum created from hedging demand associated with specific strategies. For example, option replication like portfolio insurance will create price momentum. Similarly, the rebalancing of option hedges will create momentum as traders offset gamma risk. A short option position that needs to be hedged requires buying when prices are rising and selling when prices are falling. If the demand for hedging is large enough, market prices will show intraday momentum.

The authors of this paper focus on intra-day adjustments across a set of over 60 markets and four asset classes with a sample of close to 45 years of daily data and finds strong intra-day momentum that is consistent with the strong demand for hedging short option exposures. The rest of day (ROD) has an important and statistically significant impact on the last half hour of trading (LH). This effect is especially significant for equity markets that have strong option demand and levered ETFs. The hedging demand is focused on the last half hour to avoid carrying overnight risk on short option positions. 

The research shows that the intraday effect is especially strong for equities and commodities. The impact is less for currencies where the last half hour of trading is less clearly defined.

The intraday effect declines significantly as we add time intervals. The effect is focused on hedging action before the end of the day.

The rest of the day impact is strong across all asset classes and significant relative to other configurations.

Momentum has structural as well as behavioral drivers. An intraday effect suggests that trend-followers and momentum traders can mix and match different timeframes to improve the overall performance of a momentum portfolio. 

Thursday, November 26, 2020

The November momentum factor crash - Regime and crowd changes will shock

For the second time this year, the momentum factor experienced a performance crash. Quick reversals in market expectations will lead to these negative factor events. This is especially the case for momentum which buy in-favor price moves and sells out-of-favor securities. You are trading with the herd and when it changes, it can get ugly. 

Performance is worse because there is a loss on both the long and short positions. The long in-favor stocks lose and the short out-of-favor gain so there is little protection for investors. This event can happen even if there seems to be only modest changes in the overall market.

The folks at PremiaLabs in their weekly report show the impact of the post-election crash. The same impact was found by Venn in their weekly factor performance report. Investors should be aware that momentum factors usually do not have any risk management to stop these shocks. Additionally, the construction of the factor matters. If there are no restrictions in sector, industries, or correlation as well as infrequent rebalancing, there will be greater impact  on the created momentum factor. There is no one universal definition of the momentum factor.

At the same time as the momentum shock occurred, there were gains in size and value factors. The small and out-of-favor firms gained on news of a COVID vaccine and macro expectations for improved growth. The old story driven by continued lockdown was reversing, albeit this may change again as positive COVID cases explode to the upside. We may see more of these reversals in the coming weeks. 

Like other shocks, factors correlations moved to extremes. Focusing on one factor isolates risks, but also accentuate return extremes when a regime or crowd switches.

Difference in 2020 factor returns can be seen with the return difference between momentum and value. The gain in cumulative momentum versus value returns was over 60% only to see short-term declines of 15+% and 10% respectively in June and November. Investors have to be cognizant of the rationale for why one factor may outperform another and what will be the scenario for reversal. 

Wednesday, November 25, 2020

Slowbalization, de-globalization, or a return to strong globalization - An important theme for 2021


The Economist coined the term "slowbalization" in 2019 to describe the slow growth in world trade after a period of hyper-globalization. Others have used the word de-globalization. Some of those negative on globalization have focused on the increased populism and China-US trade tensions over the last four years, but the trade slowdown problem started earlier. A good paper describing the history of the globalization and its slowdown over the last few decades has been written this month by Pol AntrĂ s of Harvard University“De-Globalization? Global Value Chains in the Post-COVID-19 Age”. It is worth a close read. 

One of the important macro themes for 2021 will be whether the slowbalization will be arrested with the new US president. A longer-term trade growth slowdown is not the same as a cyclical trade slowdown associated with a global recession. A longer-term decline is associated with slowdowns in the structural reasons for strong trade growth like information and communication technology, trade costs, trade policy changes, and geopolitical developments.

Right now the latest global trade numbers from the CPB Netherlands Bureau of Economic Policy showed a 12.5% increase in the third quarter, the largest increase since the index was started in 2000. This is consistent with the rebound in GDP for many countries. The issue is whether this increase is just an immediate business cycle reversal. The US trade deficit has exploded from consumer buying, a marked difference from the last recession. Container shipments from China have surged well ahead of numbers from the beginning of the year.

The impact of a continued slow world trade growth or a return to strong globalization will have big effect on all equity and bond markets arounds the world. Trade sensitive equities in both developed and EM markets will improve with a return to the trend of hyper-globalization. A return to higher trade will hurt more localized firms. 

We will not see a change in trade trend numbers until the COVID shock passes, but 2021 changes in the trade environment will determine whether there be a slight uptick or a return to the 1990-2007 trend.