September 24, 2010
THE RISING INFLUENCE OF BETA
The Wall Street Journal has an intriguing story today that highlights the case for thinking that macro forces are running the investment show these days. Or, to cite James Bianco of Bianco Research, as he opines in the article: "Stock picking is a dead art form. Macro themes dominate the market now more than ever."
That may be overstating the case, at least for the long term. But certainly there's a stronger argument for focusing on blending a range of betas these days. "In recent months, stocks have been moving in lock step to an almost unheard of degree," the article explains. As one example, S&P 500 stocks recently posted an 80% correlation, a measure of independence in price movement. During 2000-2006, by contrast, the correlation of S&P stocks was 27%, based on analysis by Barclays, according to the Journal.
"All stocks are moving in the same direction," says Cindy Sweeting, one of the managers of the Templeton Growth Fund. "I've spent three decades in this market, and it's the most macro-obsessed I've seen in a long time."
The article also reports:
Stock pickers say macro forces began moving stocks in a big way during the 2008 financial crisis, and that has continued this year following the European debt crisis. Traders also are focusing on the potential for a double-dip recession to hit corporate profits; on government deficits; and especially on what central banks will do about stimulus programs that pumped cash into the economy.
A host of other factors is contributing to the macro trend. The rise of exchange-traded funds, which typically track broad market indexes or benchmarks, has made it easier for investors to make broad bets on commodities, bonds and currencies. Such funds now account for 30% of daily stock-trading volume. Individual investors and pension funds have been pulling money out of stocks, leaving shares more vulnerable to trading by hedge funds with short time horizons.
It's debatable how much the rise of macro is something genuinely new. If you look at rolling 3-year return calculations for the stock market and compare it with the same pace of change for various measures of broad economic trends, such as industrial production and the ISM manufacturing index, you can see a degree of similarity. That's not surprising. In fact, cycles are ultimately at work in all the major asset classes as well as various risk factors, such as yield spreads and momentum.
The degree of macro influence waxes and wanes, of course. But it's usually the case that grabbing a properly defined measure of a given asset class's beta captures the lion's share of the risk/return profile over time. Can you do better? Sure, but you can also do worse. The nice thing about beta is that you always know what you're getting and--if you choose products wisely--at a reasonable cost.
I'm a fan of Professor John Cochrane's view that there are no alphas. Instead, as he explained to me for an article I recently wrote for Financial Advisor magazine, there are only betas we know and betas we have yet to identify.
Yes, true active management talents exists and it's worth pursuing in some cases. But it's hard to identify in advance and it can be costly. Meanwhile, the idea that you can manage a portfolio of betas is catching on. One reason is the growing recognition that if you own a multi-asset class portfolio, which is sound advice, then much of the risk and return for the overall strategy is driven by the design and management of the beta mix. In that case, it makes sense to focus on the betas.
That's an increasingly practical strategy because the menu of beta products keeps expanding. The possibilities for designing everything from a plain-vanilla balanced fund to a macro hedge fund using only ETFs and ETNs is reality. That's hardly a short cut to easy money. But to the extent that big-picture factors dominate in the long run, this is the golden age for capitalizing on these trends.
Update: Bloomberg recently ran a story that also highlighted the growing influence of macro. As the article explains:
Industry groups in the U.S. stock market are moving in lockstep with the Standard & Poor’s 500 Index at an almost record pace, showing that economic reports are having a bigger effect on the market than ever.
Exchange-traded funds that mimic the 10 main S&P 500 groups are moving with the U.S. equity gauge at almost the highest rate since 1998, when Bloomberg started compiling the data. The correlation coefficient that measures how closely assets rise and fall together exceeds 90 percent for seven of the industries relative to the index, BNY ConvergEx Group LLC data show.
Rising correlations show investors are ignoring relative values among industries and reacting to day-to-day signals on the economy, according to Mohamed El-Erian, the chief executive officer of Pacific Investment Management Co. The S&P 500 had the biggest rally in almost two months yesterday on better-than- estimated growth in U.S. and Chinese manufacturing.
Posted by jp at September 24, 2010 5:51 AM