ab9 February 2024Global Research and Evidence LabGlobal StrategyEarly warning signal incrementally more positiveEarly warning signal slightly positive, continued dispersion through earningsWe reintroduce our Directional Risk Signal to gauge the probability for near term directional risk (volatility) and low return environments. Our model is currently signaling high probability (91%) of a low return environment supportive of our expectations for near term dispersion in earnings season (link). Directionally our model has begun to skew positive.Vol has memory - "low return" probability remains elevated - VIX is currently reducing the probability of a large directional move in the model, a transition from what we had seen through COVID when the probability of low returns was often times lower than "normal". From 2017 through 2020 low return probability was > 80% 65% of days while 1mo returns >+/-5% occurred only 12% of the time. During COVID this changed significantly and from 2020-2023 low return probability was >80% only 28% of the time, and 1mo returns >+/-5% occurred 36% of the time. Since June of 2023 we seem to be moving closer to the pre-COVID magnitude of monthly returns with model expectations of low return probability >80% 61% of the time and monthly returns >+/-5% occurring 21%. Fed expectations have been a drag on directional signal - Rapid negative shifts in Fed policy expectations often lead large drawdowns, 3mo change in the 2yr forward fed rate expectations fell to levels in January last reached in Feb-March 2020 and prior to that, 2008-09. The improvement in 3mo change offered a reprieve and has offset the large negative drag on our model. A similar phenomenon occurred in Jan 2023 leading to a volatile signal to start the year. Corp HY spread supportive at UBS expected levels (link) - HY Spreads are currently around the low to mid range of UBS Credit Strategy expectations for the next few months. We find the current low levels supportive of equity performance over the next one month and within the range of expectations HY spreads' impact on our model's probabilities would remain skewed to the upside.US composite positioning remains below neutral, falling again recentlyOur US composite beta positioning measure is around 1.3 standard deviations below average, falling 1 stddev over the past month as balanced funds have reduced exposure this year and sit handily below average. Macro/CTA HFs and L/S equity HFs have increased exposure but remain below neutral. Market neutral hedge funds remain the most overweight amongst the investor types that we track. Growth MFs are slightly above neutral while Value MFs have fallen significantly underweight over the past month, Growth and Value MFs were in line 4 weeks ago. Large cap MFs have moved to ~2 stddev underweight while small caps have improved slightly to ~1 std...
