The types of trend-following systems - choose what fits

 

A recent paper tries to develop a unified theory of trend-following by classifying trend-following into three groups; see “The science and practice of trend-following systems”. 

The authors break trend-following into three types: European, American, and Time Series Momentum. 

European trend-following is based on continuous weights using an EWMA filter. In this system, position sizes are proportional to the signal strength, with the number of contracts changing day to day.

American trend-following uses channel or breakout systems with binary position sizes, so exposure is fully allocated when a signal is on. 

Time series momentum is based on the momentum of returns adjusted for volatility. 

There are parameter specifications that will deliver similar risk-adjusted returns close to the SG trend index. 

All of these trend-following systems are strongly correlated, yet there are differences in position-taking and signaling. The success of trend-following is based on the serial dependence of the underlying price series. Differences in performance will be related to differences in short- and long-term variance, and signals are related to an autocorrelation and drift term. Profits are related to an autocorrelation term even if drift is zero. 

A benign inflation number - now what?

Inflation numbers were within expectations, yet this is not something to celebrate. Core inflation is still above the 2% target, and headline inflation is still above 3%. Has the Fed been successful with its policy? The answer is no. However, the current inflation numbers suggest that no action will be taken at the September FOMC meeting. Policy changes are unlikely before an election, and that will take us to the end of the year to see any policy rate change. 

The important monetary policy information will come from the Jackson Hole conference and any headway from the five task forces reviewing policy. Chairman Warsh, if current behavior is a guide, is unlikely to tip his hand about policy at the Kansas City Fed confab, so the market will have to make decisions for itself on the direction of rates.

TIPS yields continue to move higher

 

It is not just nominal yields that are moving higher. Real yields have also been on a steep ascent, with levels at the highest in ten years. In fact, to get to these real yields, investors will have to look at data prior to the GFC. We are in a strong situation where real yields are telling investors that we have tight monetary conditions, yet inflation and nominal yields suggest that concerns about inflation are real. This places the Fed in a difficult policy environment and clearly is a reason for FOMC voting disagreement. 

Yen intervention can buy time not a solution

Always bet against intervention if there is no change in policy. Now, this does not mean you should fight a central bank in the short-term. It does mean that intervention has to continue if it is to work. Central banks are much savvier with their intervention. It will occur when there is limited liquidity. It may come through markets not expected, like EUR/JPY instead of USD/JPY. It will be followed by rhetoric to reinforce resolve. It will occur through selected banks to ensure not all are harmed. 

It can buy time but it cannot buy a solution.