Competition across nations starts at home

I was recently discussing the Draghi report on EU competitiveness and stated thinking about the old work of Michael Porter and his work The Competitive Analysis Across Nations which was an extension of his work on competitive analysis of firms. Porter developed the five forces diagram which is followed by most business students when they study strategy analysis.

For his study of nations, Porter developed his four diamond graph which is based on analyzing: factor conditions, the endowment of resources; the firm strategy or domestic conditions; demand conditions for what is needed, and the infrastructure of other industries. Governments can help with the environment, but countries do not have competitive advantage, industries do. Governments cannot make companies be more competitive. It can only create an environment that allow for competition. The private sector is where there is innovation and gains in productivity. If the EU wants to be more productive, then let companies compete gain scale and meet market demand. 

30 years of momentum research and it is only getting stronger

 

It has been over 30 years since the first major work on momentum was presented in a leading finance journal (Jegadeesh and Titman). Prior to that study, the conventional wisdom of efficient markets believed there was no trend or momentum effect. The world has changed and over the last three decades we have extensive research that has improve the initial research and strong explanations for why momentum exists. There are both behavioral and risk-based explanation for momentum and they have stood the test of time. Markets will under and overreact to new and will have different time dimensions. There is also a systematic risk component that can provide a reasonable explanation for momentum.

Momentum does not just exist in equity markets but is present around the global, in commodities, currencies, and fixed income. There is also commonality in stock momentum through industries and factors. Momentum is one of the strongest, most pervasive, and well researched factors in the marketplace. 

Of course, the strong long-term research results do not mean that momentum will always work as has been tested, momentum works strongest when there is a strong overall market sentiment. When more investors expect momentum is a given, it is more likely to have a poor performance year. There is a range of performance. 

All if this work is nicely presented in a review, see "Momentum: what do we know 30 years after Jegadeesh and Titman's seminal paper?" 

The out of control momemtum factor - can it continue?

 

The exceptional factor for 2024 is momentum. There are many ways to calculate this factor, but a simple equity benchmark is from S&P which has a broad suite of equity factors. The momentum factor is up 48% through the first eleven months of the year and is more than 50% higher than any other year and any other factor. Strong momentum factor performance does not mean a reversal in the next year, but the size of this move is extraordinary. Of course, the driver a just a few stocks which means that is not likely that this can continue if these key stocks have any slowdown or reversal. The high momentum winners may see a reversal after the one-year mark, but the follow-through on these names which have lasted for more than a year suggests that it is not a given that there will be a January effect. 

Realize that factor extremes can happen but does not suggest that there will be continuity. The rebalancing of names can support factor returns but looking at distribution properties leads to caution in holding the momentum factor.

Using generative AI for economic forecasting

 

Generative AI can be used to enhance economic forecasts through simple aggregation from corporate conference calls. We know that corporate CEO's provide economic outlooks on their earnings conference calls. It is part of the job, and it is critical that they get their forecasts right. The cost of being wrong high. Firm profits may suffer.

These conference calls provide a unique and special insight on the direction of the economy when all this information is aggregated. It is possible to aggregate all the verbal comments from transcripts using generative AI. All the information in conference call transcripts can be aggregated to form an index through highlighting key words and phrases like many other LLM models. An AI Economy Score can be employed to improve forecasts of GDP. 

Researchers have found that there is positive incremental value from using the score from the conference call transcripts. See "Harnessing Generative AI for Economic Insights". This paper scratches the surface on using AI to help with macro forecasting, but it provides a good foundation of how new tools can support better global macro decisions.

Factor investing across different regimes

Factor risk premiums are time varying and a simple approach of breaking the economy into a four quadrant macro regime world will have significant benefit. The mayor regime is based on rising or falling inflation and the composite leading indicators for the US. Both are easily obtained, and the four quadrants can be easily generated using monthly information.  Based on the factor premium indices from S&P Global Intelligence, we can identify changing factor return profiles. For the full story, see "A Historical Perspective of Factor Index Performance Across Macroeconomic Cycles". 

Specific regimes may last for long time periods only to see significant uncertainty as regime shifts come frequently. These factor returns will vary significantly. Clearly falling growth and rising inflation is worst environment followed by falling growth and falling inflation. The best environment is when growth is rising and falling inflation. 

The quality factor index shows the best returns overall returns followed by the low volatility strategy. While outperformance and hit ratios are clear during different regimes, the gains may seem small relative to transaction costs, yet a simple strategy of regular rebalancing will lead to significant gains over the longer run.    

 

The sobering impact of consequences and facts

 “Wisdom consists of the anticipation of consequences.” 

— Norman Cousins

“Consequences are unpitying.”

 — George Eliot

"Facts don't care about your feelings"

 - Ben Shapiro

“Should facts get in the way of truth?” Or, “Should truth get in the way of facts?”  

- Brad Feld  

The core of decision-making is accepting that there are consequences from actions. It is not a forecast or prediction that is the consequence. It is the action from the prediction that creates gains and losses. It is the action that has consequences.  

Similarly, facts are not feelings. Facts may differ from the truth you may want. Of course, there are interpretation of facts that may differ, but if the consequence of your interpretation is wrong, it is not the fact that is wrong. It is the interpretation. 

This may all seem obvious, yet it often requires reinforcement.