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Many times I have opined about the complete breakdown of risk parity and cross correlated models, a strategy that has surged in popularity over the last 10 years, a strategy that many including the regulatory entities believed limited risks.  Yesterday Stanford Bernstein stated this breakdown has reached the highest level in at least two decades.

Stanford Bernstein writes to many this move seems unusual and is causing headaches for quantitative funds that were believed to be the elixir that eliminated the probability of significant losses.  Bernstein writes “it appears there has been a significant change in the structure of the market, a change perhaps the result of inability of these models to think three dimensionally.”

I must write the strategist who wrote this report once stated passive investing is worse for society than Marxism given that such does not raise money for economic purposes but rather passively redistributes it based upon capitalization and momentum. Capital formation is the life blood of capitalism.

As noted many times, I believe the markets are dominated by technology based trading whose only component is momentum and capitalization.  This view is now shared by many including the Treasury Secretary and several high profile iconic financial titans.

Many times these algorithms are written based upon contents of a five word headline. Yesterday Bloomberg wrote an ETF that uses artificial intelligence to pick stocks based on comments on social media sites and “other sources” is beating the S & P 500 and 85% of active managers.

Wow!  Is this a reason why these risk parity/cross correlated models have failed?

Radically changing topics, many are convinced the US is about to enter a recession.  Yesterday the St. Louis Fed which maintains an economic model that predicts the probability of a recession stated in its January update puts the odds at less than 1%.

Wow!  This is the inverse of the headlines but is consistent with the primary Federal Reserve model that is suggesting 2019 GDP around 2.6%, about the same level of the 2.5% rate expected by the group of “30 Blue Chip Economists.”

The St. Louis Fed also validated other views which are far from consensus, but are consistent with the outlook of the Federal Reserve.  At this point any impact of announced tariffs are “relatively small” and if fully impacted will affect China more than the US.

Simplistically speaking total US exports to China is $130 billion or 0.6% of US GDP.  The US imports about $506 billion of goods from China or about 2.4% of the US economy and about 3.5% of China’s GDP.

The St. Louis Fed further commented about the manufacturing process, citing manufacturing prices could rise for “popular technology products” given the propensity of some companies to domicile their production facilities in China.

What is the point to the above?  It is widely accepted market activity is now dominated by technology based trading, trading based upon speed/momentum, capitalization and cost of execution.

A strong case can be made the headlines are misleading or at least not grounded in reputable research.

I ask are the markets now reverting back to yesterday’s norm where research and geopolitical and macroeconomic thesis’s drive investing strategy?  Yesterday the former manager of the world’s largest mutual fund, Fidelity Magellan’s Jeff Vinik, announced he is coming out of retirement to begin managing money on yesterday’s themes that propelled him and others to fame.

Just as an aside, BlackRock, the world’s largest issuer of ETFs by a wide margin announced it is cutting its global workforce by 3%, the greatest reduction in headcount since 2016 because “market uncertainty is growing, investor preferences are evolving and the ecosystem in which we operate is becoming increasingly complex.”

AQR Capital Management, the largest a quantitative asset manager, is also cutting jobs after a “dismal performance in 2018 and extreme market uncertainty.”

Commenting upon yesterday’s market activity, stocks swung between moderate losses and gains, to close moderately higher.  Oil continued its advance and Treasuries ended down about ½ point.

Last night the foreign markets were mixed.  London was down 0.23%, Paris down 0.61% and Frankfurt down 0.62%.  China was up 0.74%, Japan up 0.97% and Hang Sang up 0.55%.

The Dow should open steady.  The 10-year is up 8/32 to yield 2.72%.


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Ken Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.