To get an up-close look at how portfolio managers are considering major themes and market indicators as they navigate changing markets, we’ve asked these experts from across Natixis Investment Managers and our affiliates to share their insight:
- Jack Janasiewicz, Portfolio Manager & Lead Portfolio Strategist, Natixis Investment Managers Solutions
- David Jilek, Chief Investment Strategist, Gateway Investment Advisers
- Kathryn Kaminski, PhD, Chief Research Scientist, Portfolio Manager, AlphaSimplex Group
- Lynda Schweitzer, CFA°, Portfolio Manager, Global Bond Team, Loomis, Sayles & Co.
Jack Janasiewicz: The market has been pretty bad historically at forecasting inflation. If you simply look at some of those forward expectations and then overlay it into what actual inflation is, and match up those timelines, you’ll see huge discrepancies. Actually, the Fed has done a much better job at doing that.
For us, the month-on-month change in core CPI (Consumer Price Index) is the data point that we are paying a lot of attention to – and thus far the last two monthly prints we’ve seen were trending back to those pre-Covid levels. We did see a pretty significant surge coming out of February, March, April, and May this year, and believe it may have peaked in June. It is not surprising that the surge we saw in those month-on-month numbers actually corresponds to the same time we saw consumers buying a lot of big-ticket items. Today, consumers are now showing somewhat of a willingness to maybe wait out these higher prices. We think this is putting a lid on some of those demand factors earlier in the year. So the cure for higher prices may be higher prices. Bottom line for us, get Covid under control and the rest probably starts to fall in line. Supply chains should continue to normalize and the labor market should then ease up. Remember, there’s still millions of people in the US unemployed. That lends itself to what we think is still a transitory backdrop with regard to inflation. But, 20 months into the pandemic, inflation has risen, with prices climbing 4.4% in the year through September.
Lynda Schweitzer: As a global fixed income manager, certainly the inflation question is a big one. I think the risks have risen that inflation is more persistent than transitory. The supply chain disruptions, I think they’re being relieved, but some of those knock-on effects could last longer than we would have expected. And then wages is the other thing that we’re watching pretty closely. So it looks like inflation is going to be noisy for another 6 to 12 months as far as base effects rolling off. Some of the Covid challenges are still coming through, so we might not have a clean read on inflation for a while, and that will cause some volatility in the market.
Oil and Commodity Prices – Where to Next?
Kathryn Kaminski: From our perspective as quant investors, we look at it more from what signals are screaming at us. And when we think about the technical signals we’ve seen, the commodity markets, from a long perspective, have the highest signal-to-noise ratio that we’ve seen in the last 20-plus years.
We’re seeing extremely persistent signals in those markets, particularly agricultural, as well as base metals and the energy complex. And that’s particularly notable because it’s on the long side and we haven’t seen that in many of our back tests and many of the data sets that incorporate recent activity. The reason I say that we as quants find this terrifying is that all of these values are inputs to other systems. So there’s no surprise that a lot of people out there are very concerned. Because if oil prices double, if natural gas prices go up 150 percent going into the winter season, it’s hard to understand that that can’t have more persistent effects than we would like.
So I think from our perspective at AlphaSimplex, it’s been interesting to see something called transitory for the entire year. And so I think our view is more that, if we don’t pay attention to those signals, there definitely are indications that there will be ramifications of such a large, large move in the commodity markets.
Also, I might add that signals from the energy complex are at some of the all-time highs in terms of history. But I also give a caveat that what goes high can always go higher. And in that case, what we might have is that if this trend is really persistent, it could continue to go until we see enough against it that we could actually see it subside. But right now, it doesn’t look like anything is able to stop it yet in terms of economic forces being able to slow that down. I still see a lot of bullish signals in energy.
Volatility – Are We in for a Bumpy Ride?
Dave Jilek: It’s an interesting point that we’re at in the volatility cycle. When we think about volatility, there are two key measures of volatility that we’re constantly monitoring. The first is realized volatility and the second is implied volatility. Realized volatility, of course, is the day-to-day price changes of the broader market, so the standard deviation of the S&P 500, for example. Implied volatility, on the other hand, is the forward-looking volatility that’s priced into the options market. And domestic implied volatility is measured by the VIX Index. Sometimes referred to as the Fear Index, but the VIX doesn’t measure fear. What it actually measures is how much volatility is priced into the S&P 500 Index option market over a 30-day horizon. So it’s a measure of the market’s assessment of the likelihood of various levels of volatility over the next 30 days.
So when we analyze volatility trends and conditions, volatility conditions in the market, we look at it several different ways. Realized volatility and implied volatility are the two key measures that we look at. Obviously, we had extreme levels of both of those measures in 2020. And since the peak of volatility in the first quarter of 2020, both measures have been steadily trending downward. And for most of this year, we’ve been at kind of average to slightly below-average measures for both implied and realized.
What’s interesting about that, though, is that even though volatility measures have normalized, we’re still at a much higher level than we saw on a persistent basis for several years prior to the pandemic. We were in a persistently low-volatility environment really from mid-2012 through 2019. On this side of the worst fears about the pandemic, volatility is certainly lower than extreme levels, but still meaningfully higher than we’ve been seeing really for almost the last decade prior to the pandemic.
At Gateway, we think there are a lot of good reasons for why we’re in kind of a higher-volatility regime. But what’s also interesting is that as both of these measures of implied and realized have come down, the spread between the two has widened. It is the typical condition that implied volatility is higher than realized volatility. If you look at average levels for the VIX on a monthly basis compared to the standard deviation of daily returns for the S&P 500 on a monthly basis, there’s, on average, about a four-point spread between those two statistics. Lately, it’s been double that or more. In fact, it looks like October will be the 13th consecutive month of higher-than-average spread between implied and realized volatility. That is the longest streak of that widest spread on record, and the VIX has been around since 1990. So that’s over three decades. That’s important to what we do because the wider that spread is, the more overpriced index options are likely to be. So by writing index options, you have a high potential for enhancing risk-adjusted return.
Low Yields – Where’s the Income in Fixed Income?
Lynda Schweitzer: We’ve been yield-challenged for a while. Rates are higher this year. The percent of negative-yielding debt is down, but it’s still around 15 percent, down from 25 percent at the start of 2021. So still not a lot of yield out there in general.
I am in the camp that yields should go higher. We’re normalizing policy to varying degrees globally, but the pressure on US yields should be for them to go higher. So total returns are likely to be a bit challenging over the next 12 to 18 months. But globally, we’re looking at some of those markets where maybe the markets have gotten ahead of themselves pricing in rate hikes. I would mention the UK, New Zealand, or Canada. Some of those markets have moved faster than the Fed to remove accommodation, and the markets have glommed onto that and have really priced in hikes which we don’t necessarily think will come through. So that could offer some opportunity.
Just like in equities, credit valuations are stretched. We’re back to pre-pandemic tights. Certainly the fundamental backdrop is still very supportive for credit issuers and for corporates. So on that aspect, you might expect credit could be a clip-to-carry type of market, and that might be good certainly relative to treasury yield. But with spreads as tight as they are, there’s very little cushion if some of these risks come through and cause a risk-off environment. So it’s a security picker’s market within credit, and we’re certainly looking at some of those industries that have lagged a little bit from the Covid slowdown – such as leisure, hotels, and travel. We’re also thinking high yield looks a little bit more fair than investment grade.
The one place that is very attractive on a valuation standpoint, but maybe yet the macro backdrop isn’t there to support a strong performance yet, although I hope within the next six months that is the case, is emerging markets -- both local rates markets and currency. As the vaccine rollout throughout the world makes reopening easier in some of those markets, they have less monetary and fiscal response to the economic slowdown from Covid last year and valuations are extremely attractive. So really, I think it’s a good time to be an active manager.
Interest Rate Hikes – When Will the Fed Strike?
Jack Janasiewicz: We think the market might be getting a little bit ahead of itself in terms of thinking about where the Fed is going with rate hikes. The market has been pretty comfortable with the idea that the Fed will taper. In fact, the Fed announced at its latest meeting it will start reducing its $120 billion in monthly bond purchases in November, by $15 billion a month, though it reserved the right to change that pace. At that pace, the bond buying would end in the second or early third quarter of next year. Market reaction has suggested that the Fed would roll immediately right into rate hikes. The Fed has been pretty adamant about disconnecting tapering and Fed hikes, and says it will be patient in raising rates.
We believe the Fed may want to run the economy hot because they’re trying to broaden out the employment backdrop, get that recovery working for all workers. But at the same time, they could allow a little bit of the overheating on the inflation side, and that’s really hurting some of the people that you’re trying to help out most here. So I think the Fed is kind of stuck between a rock and a hard place here. Either supply needs to ramp up and meet that demand, or demand cools.
China – How Slow Can it Grow?
Lynda Schweitzer: From a global fixed income standpoint we’re watching China very closely. With the slowdown, the engineered slowdown there, they have been trying to cut back and bring some of the excesses out of the market. But some of the symptoms that we’ve seen in the property market and what that might mean for global growth impulse is something we’re watching very carefully. I think the reopening story, the slow vaccine rollout, while we’ve had some bumps and starts this year and it’s been stretched out longer than we thought coming into the year -- I think China could be another shock that might delay that yet again. And so that’s another theme to consider, and what that means for various markets around the world.
Crisis Alpha – Is There Opportunity in Chaos?
Kathryn Kaminski: Crisis alpha is the opportunities during periods of stress and dislocation. And so crisis alpha-type strategies, or anything that’s able to maneuver a very challenging market environment, is very interesting to many investors. Because I think a lot of us really worry about mitigating risk and being able to find things that can actually adapt well. So our type of managed futures strategies have worked well in crisis environments because it’s very hard to tell where things are going, and in fact, there are discernible trends in the global markets during these challenging environments. A good example is Q1 of 2020. There were fantastically persistent trends, including short in energy markets and short in base metals. These types of trends can provide opportunities to offset and help mitigate risk for large traditional portfolios from more of a diversification perspective.
Overall, I think there’s a lot of crisis alpha out there. Is it inflation crisis alpha? Maybe. Is it rising rate crisis alpha? Perhaps. But there’s definitely going to be a new structural change in terms of where the world and the financial markets move going forward.
All investing involves risk, including the risk of loss. Investment risk exists with equity, fixed income, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed are as of October 27, 2021 and may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted, and actual results may vary.
Commodity-related investments, including derivatives, may be affected by a number of factors including commodity prices, world events, import controls, and economic conditions and therefore may involve substantial risk of loss.
Crisis alpha opportunities are profits which are gained by exploiting the persistent trends that occur across markets during times of crisis.
Unlike passive investments, there are no indexes that an active investment attempts to track or replicate. Thus, the ability of an active investment to achieve its objectives will depend on the effectiveness of the investment manager.
VIX® is a key measure of market expectations of near-term volatility conveyed by S&P 500® stock index option prices. It reflects a market estimate of future volatility, based on the weighted average of the implied volatilities for a wide range of strikes; first and second month expirations are used until eight days from expiration, then the second and third are used.
S&P 500® Index is a widely recognized measure of US stock market performance. It is an unmanaged index of 500 common stocks chosen for market size, liquidity, and industry group representation, among other factors. It also measures the performance of the large-cap segment of the US equities market.
Index option (European-style expiration, cash settled and exchange-traded): an option contract on an index (e.g., S&P 500) in which the buyer (owner) pays a cash premium up front to the seller (writer) of the option. If at expiration, the option contract is in-the-money, the seller pays the owner cash in the amount of the difference between the option strike price and the current value of the index; otherwise, the option expires worthless for the buyer and the seller keeps the full premium received up front. The writer of an option is paid a cash premium for taking on the risk associated with the option obligation to pay if the option expires in-the-money. Listed index options contracts can be closed or traded prior to expiration date, but not exercised.
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