Retail investors love hard to value stiocks

 

How do retail investors behave? I wish I knew. It seems that they have an increasing impact on some markets, but where is the focus? A paper titled "The Retail Habitat" seeks to answer this question and finds that retail investors prefer to trade hard-to-value stocks. Stocks with a lot of retail trading have more intangible capital, longer-duration cash flows, and are more likely to be mispriced. So why do retail investors focus on the harder-to-value names? The authors do not fully explore this critical issue. They just identify the stocks that seem to have more retail focus. I would suggets that that retail traders focus on big bets, the lottery tickets. The lottery ticket names, of course, will be stocks that can possibly produce large gains.

Asset allocation is always about the stock-bond correlation

The primary asset allocation decision is based on the relationship between stocks and bonds. If the correlation is negative, there is a significant benefit to holding bonds. If the correlation is rising and positive, the bond diversification benefit is limited, and it is time to consider other alternatives. The trend is not favorable to bonds. The long-term trend is higher, though the recent trend has returned to negative territory.

Meaaurement uncertainty is real

 

Macro investors have to deal with measurement error within government data. This is the second year in which we have seen major revisions to labor data. Last year, a major seasonal adjustment affected employment numbers. This year, there has been a significant change due to benchmark revisions. The two charts below provide evidence of what has happened to the labor data. The first chart shows that nonfarm payrolls have been revised down by approximately 1 million jobs. In the second chart, you can see the monthly change.

This new data provides further evidence of the K-shaped economy. Some of the revisions are based on demographics, so they do not translate into higher unemployment, but they do create a more confusing picture of the macroeconomic environment, which will impact bond returns in particular. 

I use macro signals to improve my trend- and price-based signals, but when macro data are noisier, the value added by macro analysis diminishes.

Innovation, industrial policy and controlling the fate of nations

 

How Progress Ends: Technology, Innovation, and the Fate of Nations, by Carl Benedikt Frey, is one of the most important economic and policy books of the last year. It is especially relevant given the discussion following the Draghi Report that has influenced European thinking about the need for change and innovation. Frey makes an important argument that economic progress is a combination of innovation, which often occurs in a decentralized environment, and the implementation of scale through bureaucracy. He develops this argument through close observation of 1,000 years of history across different economic systems around the globe. Technological progress and economic growth are inevitable. There needs to be a special combination between technology and bureaucracy.

Frey draws a distinction between technological innovation that often occurs in a decentralized environment, where experimentation and exploration of new ideas take place. The technology then has to be put to use, which requires a bureaucracy or centralization to effectively employ it. Some countries did not get the technology right because bureaucracy stifled innovation. In contrast, other countries lacked technological advances but were able to grow by harnessing their bureaucracy to build on others’ innovations. 

The EU needs new technology, but that is not enough. There also needs to be a bureaucracy that not only gets out of the way but also uses its power to allow for economies of scale. 

The complexity of trade - not always simple

 

Those imports are taking away good jobs. We have to impose tariffs to stop the invasion of foreign goods to our shores. These comments all sound good, but the reality is more complex. It is usually always that way. One chart that caught my attention showed that many good imports are intermediate goods rather than final products. We take in components and assemble the final product. As an intermediary good, a tariff will increase the price of the final good. The answer could be to produce these intermediate goods in the US, but they are often specialized and may be hard to produce at low cost. Some industries are very dependent on these imports, and they do not fit the usual trade story being used to justify tariffs. Think about complexities and realize most problems are not easy yes or no answers. 

The relative US - EM inflation story

If I asked the simple question, "Is EM inflation higher than US inflation?", most would say that EM inflation is higher. It has been, and always will be, yet the reality is different. US inflation has been higher than EM for almost 5 years. That is right. The Fed manages an inflation regime that is worse than that of the combined EM economies, and the gap is widening. Do you have to wonder why the dollar is falling? 

What drives performance of machine learning

 

A recent paper, "What drives the performance of machine learning factor strategies?" seeks to disentangle two key ingredients in modeling: expanding the dataset and allowing for flexible functional forms. Now, as expected, as you move closer to a realistic setting, you find that the value of both deteriorates. However, this research finds that the value of an expanded dataset is more persistent than the functional form employed. While many may think that machine learning is a form of holy grail for investing, the reality is that real-world constraints and transaction costs are key drivers of performance. Reality indicates that adding nonlinear complexity does not add value, whereas being non-sparse is beneficial. 

Risk appetite is always worth following - Currently, normal

We have been following the Wilmot Risk Appetite Index for decades, when it was first called the Credit Suisse RAI, as developed by Jonathan Wilmot, who is now in private practice. It will be provided to investors through HedgeIndex LLC in the coming weeks, along with their broad set of alternative indexes. The basic construction is provided below. 

The current reading indicates that risk appetite is within the normal range, though it is rising. There may be individual assets with extreme values, but the RAI does not indicate a general market extreme.

 

China growth coming in lower

 

ChinaNow is a real-time, alternative measure of Chinese real GDP designed to capture business cycle dynamics in China that are not readily observable in official GDP data.  The authors employ a dynamic factor model (DFM) that draws on a broad set of high-frequency indicators informative about the Chinese economy and its business cycle.

Many are skeptical of the official stats coming out of China. In addition to methodological issues, these GDP data are politically sensitive; therefore, it is important to identify alternative growth indicators. The ChinaNow index appears to closely match official figures but provides more timely and higher-quality data, particularly during periods of slowdown. 

If there is a slowdown in China, there are stronger incentives to push exports at lower prices to keep factories humming. Hence, China's domestic growth has a strong impact on the rest of the world. 

Asset allocation of university endowments

 

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A recent survey from NACUBO-Commonfund Study of Endowments provides interesting insights into the asset allocations for university endowments. Clearly, the larger funds have allocated more to alternatives and private assets and less to bonds, while the smaller funds appear to follow a more traditional allocation.

Nevertheless, the performance of endowments is not markedly different from that of a 60/40 portfolio. In fact, over three years, the endowments underperformed the classic mix, and over ten years, only the largest endowments seem to have beaten the simple benchmark. Does that mean 60/40 is better? No, but it does indicate that adding alternatives should be done carefully, with an eye to how they may compare to a simple approach.

King dollar - can it be toppled

 

I was expecting a standard book on the history of the dollar’s rise, and the reasons it should be a dominant currency, as well as why it will fall. I have read many articles on this topic and thought I would get more of the same with King Dollar: The past and future of the world’s dominant currency. I was surprised by something different. While I don’t always like the breezy approach of new reporters to complex economic topics, I found this an interesting read. 

Blustein takes the reader on a different ride, focusing on the plumbing of banking through SWIFT messages and CHIPS. It provides a unique look at the history of clearing and the ascent of the dollar that many monetary theorists avoid. More importantly, the author focuses on how the anti-money laundering efforts of the US Treasury have an important impact on banking and the use of the dollar. There is a vast amount of behind-the-scenes efforts to control the flow of dollars for the benefit of the world economy, yet this interference has a dark side that leads some state actors to avoid surveillance. The attempt to restrict Russia from global banking and trade shows how regulation and oversight can affect the flow of money. The author also reviews the work to develop CBDCs, central bank digital currencies.

As alluded to in the final chapter, for the "king currency" having a throne comes with great responsibility.

 

Buffered ETF - the product of 2026?

 

For better or worse, the top ETF product for 2026 may be the buffered ETF. At a very general level, a buffered ETF, is one that provides downside protection versus some referenced index. That is, there is a buffer on the losses associated with the ETF. However, in exchange for this protection, the investor wil give-up some of the upside. The market has grown from approximately $5 billion in 2020 to a $90 billion AUM as of the end of 2025.

This type of protection can be achieved by managing the portfolio. There is a cost with having the ETF provide you protection, yet there always seems to be a need for these products. First, the mechanism for offering this protection is systematic and removes emotion from any allocation decision. Second, the timing of the protection is well-defined. Yet the payoff structure is complex and comprises multiple option positions. There are parts of the distribution that are protected or buffered, parts that are exposed to risk, and an upside portion that is capped. The folks at Alpha Architect provide a good overview of the problem. 

Realize that if you want protection from downside risk, there is no free lunch. If you move to cash, you lose the upside. If you buy derivatives, there is a cost. If you allocate to alternatives, you are at the mercy of their return profile. Choose your protection wisely.

What are the big risks of 2026?

Each year, the World Economic Forum provides a global risk perception survey. This is one of the most comprehensive risk surveys, and it provides useful context on what business leaders are thinking about potential disruptions to the global economy. The benefit of this survey is that it provides overall rankings for each year and measures change from the prior year.

By far, the current global risk landscape identifies geoeconomic confrontation as the top risk, followed by state-based conflict. Now, for anyone reading the news, this seems very logical, but it is sobering to see it in print. It has moved up from the eighth spot last year to number one. Along with confrontation, economic downturns, inflation, and bubbles pose key risks. These risks are important in both the short and long term, although climate change is still considered a long-term risk.

What does this mean? First, it is hard to believe that risky assets will continue on the current path with these views. Second, as noted in a recent post, Bonds are not always a safe asset; holding bonds may not provide the desired safety during an armed conflict or war.

 

Credit spreads tells about financial risk

 

The paper, “Credit Spread News and Financial Market Risk,” examines a simple issue. Do the changes in bond spreads tell us something about financial risk that we do not already know? The answer after significant analysis clearly indicates that there is something in credit market pricing that provides insight into the behavior of volatility, as measured by the VIX, realized volatility, and GARCH modeling. If there is a shock to credit spreads, there will be a spillover to higher volatility. Now, this shock effect is centered on recessions, but the evidence is clear. Follow debt markets as another tool to tell you something about financial risk. 

Bonds are not always a safe asset.

The new paper "Are Government Bonds Safe in time of war and Pandemic?" examines the behavior of bonds during periods of war and other non-financialcrises. Not surprisingly, there is a difference. Wars are associated with sharp declines in real returns and with returns that lag growth. The reasons are clear. There is elevated surprise inflation during a war, and governments impose financial repression, which creates a wedge between real returns and grwoth/. The bondholders bear the cost of war, even relative to risky assets. That is not the case during a financial crisis or a pandemic. Pandemics are similar to war in that they entail labor supply constraints, trade restrictions, a surge in spending, and significant increases in central bank balance sheets. 

All risks are not equal. Bonds are not always safe. The assumption that government bodies are always safe will be costly. Now, the war scenario may be easy to adapt to, but the real question is whether there are other government or geopolitical-induced events that are adverse for bonds. That is the real current question. When is the environment not safe for bonds? 

China is run by engineers - the US by lawyers - a different perspective

 

Dan Wang, a China-based reporter for many years, writes an insightful book about his impressions of the Chinese economy and political system in Breakneck: China’s Quest to Engineer the Future. The premise is that China's economy and political system are run by engineers, who are the key filter for understanding their leaders’ actions and behavior in addressing problems. In contrast, the US is driven by lawyers who are not builders and doers but activists who want to stop and control the economy and politics through the legal and regulatory system. On the surface, this dichotomy seems simplistic, yet Wang makes a strong case that this is an effective characterization. He does spend most of his time using the engineering framework to explain China, the center of the book, and his contrast with the US is not as well developed, yet I found this may be a good way of thinking about actions within China.

This is a short, very personal book, so do not expect deep analysis. Yet the presentation is compelling, and for those who want another perspective on the Chinese economy, it is a good read.  

Hedge fund rotation in 2026

 

Every year, we see investors change their appetite across hedge fund strategies, and 2026 is no different. There generally is a momentum component to hedge fund allocations. Strategies with strong performance will see strong interest in the following year.

For 2026, we are seeing increased interest in European hedge funds and in multi-strategy and event-driven strategies. There is also increased demand for digital assets, but we believe the current sell-off has cooled interest in these strategies. Interest in multi-strategy strategies has been the strongest among hedge fund strategies over the last few years. The low volatility and strong Sharpe ratios have been the primary drivers, despite the strategy’s high fees.

The value from trend-following is in the quintiles

 

The Mann Group provides another simple chart that explains why investors want to hold trend-following managers. We have seen the quantile chart before, but the comparison with global bonds and multi-strat provides more insight. First, we have higher-yielding investors who think they can just hold bonds as a safe asset. Bonds will not help you at the downside extreme. The darling of hedge funds has been multi-strat firms. They will do well in most cases except for the lowest equity quantile. When you need protection wuou will not get it. 

Strategy blend is important. Take a combination of trend and multi-strat, and you will be well served across all states of the equity market. 

“Low-hire, Low-fire” labor environment - Labor gridlock

In a K-shaped economy, we are seeing labor market gridlock. Job openings are falling, and separations are low. Quit rates are also at the lowest levels since the pandemic. Workers do not want to leave their jobs. Firms do not want to hire workers, nor do they want to fire them, because they don’t think they can find better workers. Turnover is a good sign for a labor market, and we are not seeing this in the US economy. The economy is gridlocked on uncertainty. If you don’t know what the future may hold, you don’t want ot make new investment decisions in labor or capital. 

Putting Fed dissent in perspective

 

Whenever there is dissent with Fed votes, there is an uproar by market analysts who are trying to make sense of why someone would have a different opinion. Indeed, dissents have increased, but the absence of dissents was unusual during the Powell period. If you look at other periods, the number of dissenting votes was greater and more often. Greenspan was the exception with few dissents, but that was only later in his tenure as Chairman. During the Volcker period, one could say the Fed was in revolt. 

The lack of consensus is beneficial. Yes, it creates uncertainty, but it also tells us there is honest debate.

New CME margin for silver and gold futures - fixed percentage of noitional

The CME has set new margin rules for gold and silver. The CME says this is a procedural change with no significant impact on the margin market, but we think it is a much bigger issue and will eventually affect all markets. Traditionally, margins are set as a dollar value tied to the contract's notional value and volatility. It should cover more than the expected most significant one-day move. The link between VaR and margin in this setting is unclear; there is no direct link, and it is determined by a committee. There is a process, but it is not mechanical, and the underlying assumption is that margins will remain relatively stable over time unless market behavior changes significantly.

The new procedure that went into effect for the gold and silver markets is now based on a percentage of notional value. Hence, if the value of the gold or silver contract increases, there will be a corresponding increase in margin. In a rising market, the longs will have to post more margin on their gains instead of being able to take their notional gains out of the market. In practice, most traders will not take excess cash from their margin account until there is a gain in cash balances. In the case of shorts, when there is a gain in the market, there will be a need to post more money. The average cost of shorting will be higher.

Now, at the end of the month, the CME increased the margin percentage for gold and silver, so the margin required for those contracts needed to be posted again. 

Gold margins rose to 8% of the value of the underlying contract from the current 6% for a non-heightened risk profile, and the heightened risk profile margins increased to 8.8% from the current 6.6%.

Silver margins climbed to 15% from the current 11% for a non-heightened risk profile, while the heightened risk profile margins moved to 16.5% from the current 12.1%. Platinum and palladium futures' margins were also boosted.

Are we creating the wrong macroeconmic statistics?

 

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The book The Mismeasurement of America: How Outdated Government Statistics Mask the Economic Struggle of Everyday Americans, by Gene Ludwig, the former Comptroller of the Currency and the Ludwig Institute for Shared Economic Prosperity, is a thoughtful, concise analysis of a critical issue. Do we measure unemployment, median wages, and inflation effectively? The answer is no. Before you say this is only a policy issue, consider the current discussion of a K-shaped economy.

The simple question is: why do American workers feel so stressed when employment, wage, and inflation numbers are either positive or tame? The answer is that our statistics on these key issues are problematic. 

They tell a story, but reality may be different. For example, inflation appears to be under control, although it exceeds the 2% target; however, if we focus on a basket of everyday necessities, inflation is much higher. Unemployment is low, but if you adjust for part-time and low-wage work, the functional unemployment rate is higher. If we consider an alternative wage scale based on actual time worked, we would see wage earners falling behind.

We need better, more informative data. We can address the fallout from politics, but we first need better facts.