alpha and strategy medium
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S t e v e n M o r a l e s : P r i v a t e a n d C o n f i d e n t i a
l
A Focus on Alpha & Strategy
The following pages contain 4 things:
1) Alpha generators
2) Excerpts from strategy presentations made to clients over the last few
years that are based on personal (in-house) proprietary research
3) Dashboards
4) Optimization tools
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S t e v e n M o r a l e s : P r i v a t e a n d C o n f i d e n t i a
l
A Focus on Alpha & Strategy
1) The Alpha generators:
These are visual basic work environments that allow for uploading any dataseries, such as a macroeconomic data, and using simple transformations,search for and rank the best drivers for a given asset. These relationshipscan be simple ways to produce forecasts.
Simple examples: one could set up an experiment to find the most relevantmacroeconomic data for predicting the price of the S&P 500 6 monthsforward or the price of Oil 6m forward. Any asset can be analyzed. Anyquestion can be considered.
Key takeaways: 100’s of drivers may be considered at once. Lesser known butvalid relationships between fundamental data and markets can be found,helping to find some structure in otherwise “incoherent” market behavior,100s of forecasts can be made at once, i.e. automated for consideration,discussion, visual representation of ideas, clear, repeatable methodology,
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A Focus on Alpha & Strategy
1) The Alpha generators: Macroeconomics vs Assets:
The research process ranks drivers in terms of relevance to create or
“show” interesting relationships. Once those relationships have been
chosen by the portfolio manager a series of forecasts can be created
for each asset.
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Example: Forecasting the S&P 500, ranking indicators,
multiple forecasts and probability distribution
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A Focus on Alpha & Strategy
1) The Alpha generators: Company fundamentals for forecasting forward
stock returns
A core group of company metrics, such as earnings growth, sales
growth, ROE, dividend growth can be used to adjust valuation and
then forecast share price returns.
The model chooses between multiple multifactor models based on
simplicity and reliability.
Key takeaways: large caps stock returns are many times dictated by
simple metrics, however, each company (Cisco vs Intel) may besensitive to different factors and to different degrees. Automating this
process of determining direction and magnitude for expected returns
across an equity universe is extremely important and easy.
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Forecasting share prices using P/L metrics and valuation
Example: Apple Computer
The red line is the model prediction of
Apples 6m forward return.
Here it is observed that a slowing of share
price returns was coherent with the rate of
the change of the basic fundamentals of the
business even back in early 2012.
A Focus on Alpha & Strategy
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A Focus on Alpha & Strategy
Fundamentally driven return expectations can be produced in mass, for comparison
and discussion
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A Focus on Alpha & Strategy
1) The Alpha generators: Optimal return portfolios and management
“Clients should expect to receive asset returns adequately
compensated for risk.”
Eliminating or tactically hedging portfolios and assets during periods of
“bad future risk” reduces volatility and is a valid profit hoarding
strategy. These models identify key volatility levels for assets: stocks,
bonds, etfs, commodities, currencies, asset pairs, etc.
Key takeaways: these models are not asset selectors but asset
managers, the tactical hedging frequency is medium 12x per 5 years,the exponential cumulative wealth effects of reducing exposure during
periods of bad volatility are impressive. The tactical hedging signals
can be generated for an entire universe of assets. Monte Carlo stress
testing suggests that this strategy is a good one, but definitely not “the
holy grail”
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Tactical Hedging: clear and simple “profit hoarding” methodology for
stocks, bonds, etfs, commodities, currencies and pair trades.
“Optimal return” models for any asset…
A Focus on Alpha & Strategy
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A Focus on Alpha & Strategy
2) Strategy excerpts: 2009 – 2013
The macroeconomic alpha generators – or financial markets
relationship analyzer has been a great source of idea generation and
generalized clarity in a many times confusing market place for
investing and discussion.
However, the key to a coherent strategy have not always required
original or complicated explanations. The December 2012 message
to clients was all about,
“Fed liquidity support of asset prices could be counted on given the still high levels of structural unemployment in the United States, keeping GDP
below potential and variations of the Taylor suggested -400 bp of easing
was probably in order.”
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A Focus on Alpha & Strategy
2) Strategy excerpts: 2009 – 2013
Even so, one of the more interesting strategy pieces I wrote and
spoke about near the end of the 2009 crisis was based on a new
model I had made for forecasting core inflation. Intuition, curiosity and
research showed that potentially the future shape of “everything” was
based, directly or inversely, the shape of future inflation”. The topic atthe time was “deflation” and forecasts showed it was improbable,
already, but that stocks prices might flatten as a consequence.
Next 18 months core Inflation
forecast
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Strategy excerpts: 2009 –
2013
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Strategy excerpts: 2009 –
2013
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A Focus on Alpha & Strategy
Strategy excerpts: 2009 – 2013
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“Against all Odds” the U.S.Economy is recovering mildly
but consistently in the face of aglobal slowdown and importantfinancial systemic risk fromEurope
• Stable to impoving companyearnings, normalized creditconditions, cash returns toshareholders (buybacks anddividends) a better housing
market, a “comitted” FederalFederal Reserve (QE3 / GDPTargeting), and a positve windfrom the Election year allsupport a stable riskenvironment and mild (1H) togood (2H) stock market returns
US Macroeconomics
M a c r o
I n v e s t m e n t s
InvestmentPolicy
Sectors and
Stocks
Until evidence of further monetaryand politicalsupport:UnderweightFinancials,Commodities
Overweight:Stable Growth
“Against All Odds” - Mild Recovery and Election
Year Supports “Mild to Good” Returns and Lower
Risk in 2012
Inspite of stable
earnings and risk,sector and stockselection 1H 2012should stillrecognize thefollowing risks:
1) the globalslowdown, 2)
financial systemrisk and 3) thepossibility of onlyrange boundmarkets 1H. S&Pp.obj: 1359
Strategy excerpts: 2009 –
2013
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I) Mild Growth &
Corporate Action
II) Systemic Risk
from Europe
IV) Presidential
CycleIII) Policy Action
(Fed)
Growth
Business activity, GDP,
leading indicators,
lending conditions,housing PLUS
corporate cash returns
Policy Action:
Fed recognizes the
need to improve
economic conditions
further (QE3, GDP
targeting)
Systemic Risk:
Financial Risk indicators
are showing alarm bells,
even as macoeconmic
contiions improve, thanks
to the crisis in Europe
Presidential Cycle:
A better and well
supported economy could
help Obama return to the
White House. Worst case,
less grid lock in
Washington.
II) Systemic Risk
from Europe
“Against All Odds” - Mild Recovery and Election
Year Supports “Mild to Good” Returns and Lower
Risk in 2012
Strategy excerpts: 2009 –
2013
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Confidence (+)
Housing (+)
Inflation Expectations
(+)
Personal Income (+)
Expenditures (-)
Savings (+)
Credit
Supply (Lending) (+)
Demand (-)
Unemployment
(+)
GDP and Components
(+)
Leading Indicators
(Conf Board)
(+)
Business Conditions
(ISM, Philly Fed)
(+)
NBER Business Cycle
(+)
Macro Matrix – showing improvements accross the board
“Against All Odds” - Mild Recovery and Election
Year Supports “Mild to Good” Returns and Lower
Risk in 2012
Strategy excerpts: 2009 – 2013
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Strategy excerpts: 2009 –
2013
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Strategy excerpts: 2009 –
2013
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Strategy excerpts: 2009 – 2013
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Strategy excerpts: 2009 –
2013
Consumer confidence vs S&P 500
“Against All Odds” - Mild Recovery and Election
Year Supports “Mild to Good” Returns and Lower
Risk in 2012
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Circle - puzzle
ISM New Orders is inversely correlated to Pharma (-0.82)
“Against All Odds” - Mild Recovery and Election
Year Supports “Mild to Good” Returns and Lower
Risk in 2012
Strategy excerpts: 2009 –
2013
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Circle - puzzle
Strategy excerpts: 2009 –
2013
“Against All Odds” - Mild Recovery and Election
Year Supports “Mild to Good” Returns and Lower
Risk in 2012
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Circle - puzzle
Expect Stocks to Beat Bonds by 10%
“Against All Odds” - Mild Recovery and Election
Year Supports “Mild to Good” Returns and Lower
Risk in 2012
Strategy excerpts: 2009 –
2013
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Circle - puzzle
Expect Stocks to Beat Bonds by 10%
“Against All Odds” - Mild Recovery and Election
Year Supports “Mild to Good” Returns and Lower
Risk in 2012
Strategy excerpts: 2009 –
2013
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A Focus on Alpha & Strategy
3) Investment Dashboards
Dashboards are useful for visualizing strategy and showing even a large
array of forecasts
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Investment Dashboards
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Monitoring global indices
Investment Dashboards
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A Focus on Alpha & Strategy
4) Optimization Tools
Research into developing interesting metrics measuring the smoothness
of returns when comparing trading strategies was useful for the much
simpler task of portfolio min var optimization.
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Portfolio Optimization
Targeting beta, ir ratio, “smoothest return”, alpha slope etc, sector weight
ranges or any other desirable metric
Optimization Tools