Wednesday, November 4, 2015

Managed futures - difficult month with market reversals

Equities saw the best month this year with a total return of over 8 percent for the SP 500, but the good news in equities did not translate to positive returns for global macro and managed futures strategies. Both the BTOP50 and Newedge CTA index posted negative returns. Returns have moved sideways for the last five months for these strategies and are significantly off the highs seen at the end of the first quarter.

Diversification can be a two-edged sword for managed futures with many of the other markets sectors seeing reversals and little net change for the month. Even equity returns were the result of a sharp reversal at the end of the third quarter, so the managers who were short the longer-term trend were caught with losses during the first half of the month. The key theme  for the month was risk-on, so fixed income reversed gains in the second half of the month as money flowed to equities.

Central bank liquidity was the driver for this risk-on switch. With Fed action pushed out to at least December and more likely 2016, ECB comments from president Draghi that more QE is likely in Europe, and a major reflation in China, the markets have jumped on the liquidity bandwagon. Arguable there are reasons for more liquidity as global growth seems to be slowing. In this risk switch, trend-following was not the proper strategy play.

Equities - One again, we learn that it is never good to fight central banks. It does not matter whether  current central bank guidance is muddled. If there is a tilt to easing, risk assets will be demanded. Don't fight central banks.

Fixed income - Bond prices for the year peaked in October with global rates moving higher on central bank messaging. Yields in the front-end of the curve increased in the 3-6 month range under expectations that the Fed will make their policy change by March 2016.

Currencies - Money moved to the dollar and away from countries that presented more expansionary credit or dovish talk. EM market outflows may have slowed versus the last three months, but the risk-on trade has not really reached these markets. Given Fed uncertainty, the dollar has not reached new highs. There was not enough price action for strong trend opportunities.

Energy - Natural gas continues to move lower while crude oil has been more range-bound but with higher volatility. The oil market has bounced off lows in the mid-40's but there are not fundamentals that will push oil higher. Slowing global growth is not going to solve the current supply glut.

Metals - Precious metals were range-bound. With no inflation or geopolitical risk, there is no reason   for increasing allocations. Industrial metals have bounced near year lows. The weakness in industrial China will not allow prices to move higher. Rationalization of supply does not happen quickly.

Commodities - There was little to exploit in the grain markets. The presence of V-shaped pricing formations made for poor trend opportunities ins one of the softs and those trends that did exist were in generally low allocation markets.

Th lessons from October are clear. Range-bound markets are never good for managed futures or global macro. Whether trend-following or fundamentally driven, these traders need divergences that create meaningful price signals that can be exploited. Markets that were not range-bound showed strong v-shaped patterns. In the transition, trend-followers or major fundamental traders will not make money. The adjustment from one direction to another is always going to be painful.  These changes were not dramatic outside of equities, but enough to drive returns into negative territory. 

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