CORRELATIONS and MARKETS
ISSUE # 81
Hi All,
We are in an interesting situation where both equity and fixed income markets are under pressure at the same time. Historically, equities and fixed income have been inversely correlated, see the chart below (1998 - 2019), which promotes rebalancing to take advantage of market dislocations.
However, we can see from the chart above that the inverse correlation has shifted to a positive correlation (2019 - Present), i.e. stocks down, bonds down, risk on, risk off. This presents a significant challenge to investors as most portfolios use fixed income holdings as a ballast against risk they take elsewhere in the portfolio, primarily i the form of equity risk premium, both public and private.
A positive correlation between stocks and bonds makes it difficult to re-balance a portfolio without crystalizing losses, which often leads to investors to “wait it out” to avoid locking in a permanent loss. Thus the benefit of re-balancing a portfolio, which improves long-term performance, is lost.
If you would like to learn more about the benefits of re-balancing a portfolio check out Arun Muralidhar’s paper here. This paper offers a fresh perspective on SMART re-balancing.
MARKETS:
It’s been a rough year in the stock and bond markets, no sector remains untouched with the exception of energy and healthcare. Below is a Heat Map for the S&P 500 reflecting Year-to-Date performance.
A little over a week ago, in the August 21 MacroCrunch I wrote that “the next couple of weeks will be very interesting to see if the market makes another run at the 200 day moving average or whether it resumes the downtrend for a retest of the lows”. Well, it didn’t take long to see that the markets are retesting the lows.
Going back to my roots on the floor of the Chicago Board of Trade, I would say that the technical support area for the S&P 500 is around 3,200. This is not investment advice, but rather the 3,200 level is a .618% Fibonacci retracement of the entire move from the pandemic lows of 2,200 to the December 2021 highs of 4,800.
Fibonacci ratios have a funny way of showing up in nature and the markets.
TOP 20 LIST:
The above brings me to the next order of business which is to put together a shopping list of publicly traded stocks that I would like to buy when there is blood in the streets. As many of you know Jennifer and I went to a 100% cash position in early April of 2022, we’ve only done this once before back in July of 2007. I don’t expect to see the carnage that we saw in 2008 / 2009, but I do think that we are approaching an excellent long-term buying opportunity and I want to have my shopping list ready.
Send me your top 2-3 ideas with a couple sentences on why you like it and why now is the right time to buy it. I am particularly interested in what catalyst will drive growth over the next 5 - 10 years to create a minimum of a 10X gain in the stock price.
I’ll share the final list with those who submit recommendations.
PODCAST | VIDEOS:
MACROCRUNCH - EPISODE #3: In this episode, Arun Muralidhar and I discuss portfolio construction and the importance of re-balancing your portfolio on a consistent basis. I believe that this is a critical component to the long-term success and health of a portfolio.
FAREED ZAKARIA GPS: In this video clip the Fareed Zakaria, the host of CNN’s Global Public Square, makes the case for the need to reform the immigration and asylum process in the United States referencing Sweden and Italy’s recent populist elections which are largely a result of a chaotic immigration process that is overwhelming both countries fiscal budgets and social services. You can also read the Washington Post article here.
I hope that you enjoy the letter as much as I enjoyed writing it and please feel free to share the links with friends and associates. If you are interested in startups and are an accredited investor you can join over 750 other backers that follow my AngelList syndicate here.
Stay safe and stay well. Sean Bill / MacroCrunch / Twitter