Macro

With the correct set of risk management practices and quantitative investment analysis, returns north of 50% can be generated from recessionary global events. For a diversified portfolio of stocks or property, this offers complementary returns which permit wealth accumulation no matter the economic climate of the day.

Such a strategy does, however, require some understanding of where we currently are in the business cycle.

The late-stage bull market

Firstly, let’s review what some of the world’s most astute investors have been saying about the current global economic outlook.

Jeffery Gundlach is one of the world’s best investors. He’s the founder of DoubleLine Capital LP (which has north of $120b of FUM) and was one of the few who saw the GFC coming. Gundlach recently flagged that he believes there’s a 30% chance of a recession in the next 6 months, 50% within the next year and a ‘very high’ chance within 2 years.

Gary Shilling, President of A.Gary Shilling & Co, correctly called the Global Financial Crisis as well as the long stagnation thereafter. Shilling recently put the probability of a recession beginning in 2019 at 66%.

Ray Dalio (who I’m sure to Livewire readers needs no introduction) in a recent interview with Fox Business noted, "it's important to then say where … we are relatively late in the shorter debt cycle. We can tell by operating rates and unemployment rates and so on fairly well along in there and we are very late in the long-term debt cycle ...

So what is the historical record when we get to this converging end of the short-term debt cycle in the long-term debt cycle. I mean are we in for another debt crisis?"

Our thoughts

To investors of Vega Capital, this is not new news, in fact, we’ve been talking about these trends in every single monthly report since January. If it is true that we’re at a very late stage in the economic cycle and then the next stage must be for a bust.

But let’s not run to our fallout shelters just yet. The bull market could end in a few months’ time or perhaps next year, so careful execution of a short is paramount. We don’t want to be right on the view, but wrong on the trade because an early short is far more costly than a late long. This is why we remain cautiously long market exposure and will retain this delicate position until the timing is indubitably right.

As such our algorithms are closely observing debt markets, employment numbers and momentum to ensure we pull the short trigger at the right time.

To generate returns of a magnitude such as 50% or more when the recession does arrive, careful investment selection is required. We utilise a set of quantitative algorithms which can review thousands of investments in minutes to find positions with a high payoff/tolerable risk profile and create a suitably optimised portfolio.

The below example shows the hypothetical value of a $1 million dollar portfolio (currency hedged) utilising this investment selection algorithm over the GFC. The blue line is the model portfolio whereas the red line is a portfolio comprised entirely of the S&P500 index with dividends reinvested. 

As shown, it’s clear that whilst a recession does present risks for investors, it can also provide ample opportunity for growth.



Comments

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Mark Dawson

You say algorithms and I say what! How many everyday investors and readers of these articles use algorithms? We all know that at some point the market is going to head south. What we need to know are the best asset classes to invest in so that we can profit from a recession. Gold producing companies? Maybe?

Scott Shuttleworth

Hi Mark, thanks for your comment. We don’t unfortunately provide an investment signal service, nor advice on how individuals should diversify their portfolios with respect to asset classes. The most we can do as a wholesale fund is tell you what we’re seeing and what we’ve decided to do with the money that our investors have entrusted to us. These are legal restrictions which are enforced by ASIC. Even without those restrictions, however, we’d never tell individuals what to buy and sell. We’d get no thanks for getting it right and all the blame if it goes wrong. But what you do get from my article is a view of the economic outlook which is based on many years of model/algorithm development...for free. That’s no too bad at all.

Gary Spink

Backtesting with so few data points is not statistically significant. In other words, what worked then probably won't work next time.

Scott Shuttleworth

Hi Gary, thanks for your comment. You're right, backtests with a few data points aren't significant. This is why we've studied the performance of our macroeconomic algorithm back 100 years.