Powell Put in place after AEA comments

Every Fed Chairman has their own variation on the market put strategy; Greenspan, Bernanke, Yellen and now Powell.  We can call this new one the "everything on the table" put strategy where the guidance of yesterday tells us nothing of what might happen tomorrow. This may be a reluctant put. Powell may have tried to stay the course for tightening, but a bear market can change the mind of many a well-intentioned central banker.

The Powell comments at the American Economic Association meeting were fourfold:

• “We’re always prepared to shift the stance of policy and to shift it significantly if necessary.”
• "Listening sensitively to the message that markets are sending" (like in 2016).
• "We will be patient" 
• "Wouldn't hesitate to adjust normalization" (from the comments in December, "I don't see us changing that..")

However, the Powell put was already being structured in comments by a number of Fed officials since the Jackson Hole Conference when they have stated that the Fed will be sensitive to current economic and market data.  It is now more explicit. 

It is clear that the market has been expecting a change in Fed behavior from the policy of staying the course, just look at the probability of a rate hike since November. The market has believed that the Fed Chairman Put is still alive and well.

There should be no question that the Fed uses more than a Taylor Rule to determine rates; include financial stability. The Fed does not want to be known as a destroyer of wealth. 

Managed futures - Provided return and diversification during difficult December

With strong trends in both bonds and equities, managed futures generated good positive returns for December. The index average does not do justice to the positive performance for some managers. For example, the CS Managed Futures Liquid Index was up around 6% for the month or four times greater than the SocGen CTA index. All of the CTA indices from BarclayHedge reported gains except for Agricultural traders. Managed futures also did well versus other hedge fund strategies and proved to be uncorrelated during the December market disruption. Versus other hedge fund strategies within the Credit Suisse liquid beta universe, managed futures outperformed other strategies by 600 to 900 bps. 

Managed futures funds were able to take advantage of the dislocations in markets from both the long and short-side and were able to effectively position portfolios with the current longer-term trends. Short-term traders showed more mixed performance given the strong intraday ranges seen in markets, but again there was a wide range of winners and losers. The only reason why returns were not larger was because many managers volatility target positions and portfolios. Risk exposures were down in December.

While one month does not make a year, the good performance during a volatile market period may give investor pause about allocating away from managed futures in 2019.  

Strong trends across most market sectors

December was a great trend environment for those focused on intermediate to long-term timeframes. There were profitable opportunities in both equity indices and global bonds. Equity index trends flipped early in December and have accelerated albeit with greater intraday volatility. Bond trends continue on slower macroeconomic growth numbers and the perception of a more dovish Fed. Strong signals exist for short, intermediate and long-term timeframes. There are also strong rate trends as Fed expectations radically changed. Currencies generally show downward trends except for Japanese yen. Nevertheless, these trends are more mixed relative to bonds. Precious metals show upward trends while base metals are generally down. The energy complex shows short signals even with declines in OPEC production. Commodities also show downtrends.

The value of these trends may not have shown-up in performance numbers for trend-following firms because of the higher volatility and the Christmas holiday season. Managers who size positions on volatility have cut exposure in many markets from what was seen a few months ago. Similarly, many managers will cut positions based on liquidity concerns over the holidays. Those firms that trade without liquidity constraints or volatility positioning and targeting likely performed better this month.

If it keeps on rainin' levee's goin' to break When the levee breaks I'll have no place to stay.

If it keeps on rainin' levee's goin' to break

If it keeps on rainin' levee's goin' to break

When the levee breaks I'll have no place to stay.

-Led Zeppelin

The levee broke in December with heavy selling of equities. Long duration Treasury bonds offered protection through its negative correlation with stock but there was little to make investors happy for the year. In some cases, the entire year’s return was swiped out in one month. Some analysts have suggested that this is the first time where almost all asset sectors and categories generated negative returns. Bad technicals, a change in sentiment, policy uncertainty, weaker growth data, increased expectations of recession, an inverted yield curve, the continued increase in rates by the Fed, lower liquidity across central banks, a US government shutdown, and tariffs wars can all be used as reasons for the fall. Any one reason seems excessive, but the combination has proved to be too much for further market increases. 

There are good reasons to argue that markets have overreacted, but a simple asset allocation decision is perhaps best - don’t fight the trends. A trend is the aggregate weight of changing market opinions and there has been a sea change. You may disagree, but the cost of being wrong or fighting the headwind is high. Being defensive and waiting for new information will not provide a first mover advantage, but it also allows for better principal protection. However, making significant changes to exploit the December drop may be late especially if there is no reinforcing information.