October Market Recap: Missing Data, Strong Equities, and more | Systematic Investor | Ep.374

Episode Overview

• The discussion opens by questioning the market's reliance on constant economic data, using a recent government shutdown as a case study for how markets function in an information vacuum.
• It explores the limitations of relying on historical data in systematic investing, emphasizing that market regimes can shift and alter the behavior of traditional asset classes like bonds.
• The conversation highlights an unprecedented market shock, dubbed "Liberation Day," which defied historical backtests and underscored the need for robust risk management.
• The episode concludes by examining the growing role of alternative investments, predicting a major shift where strategies like managed futures move from a peripheral allocation to a core component of investor portfolios.

Key Concepts

• Data Dependency vs. Market Routine: The market's perceived need for constant economic data may be more about disrupting established routines for media and investors than a fundamental necessity for market function.
• Limitations of Historical Data: Past performance and asset correlations are not reliable predictors of future behavior, as market regimes can fundamentally shift, changing how assets like bonds behave.
• Diversification of Thought: True diversification extends beyond asset classes to include different investment methodologies, assumptions, and schools of thought to avoid over-reliance on a single worldview.
• The "Liberation Day" Anomaly: A discussion of a recent, unprecedented market event involving three consecutive days of significant, correlated shocks—an event never seen in historical backtests, highlighting the limitations of such models.
• The Rise of Alternatives: A significant trend where alternative investments are projected to grow substantially, potentially shifting from a satellite allocation to a core holding in portfolios as the traditional 60/40 model shows its limitations.
• Opacity in QIS: A critique of the lack of transparency in the large and influential Quantitative Investment Strategies (QIS) space, which may be larger than the official CTA industry.

Quotes

• At 1:10 - "Trends are working well again, so that's exciting." - Katy Kaminski comments on the positive performance of trend-following strategies at the time of recording.
• At 3:07 - "Despite whatever it was, 40 days of no government data, the markets didn't really seem to be too bothered about that." - Niels Kaastrup-Larsen notes the market's surprising resilience during the halt of economic data releases.
• At 3:26 - "We're so used to the routine. Here's non-farm payrolls, here's this...and I think people are a little out of sorts." - Katy Kaminski suggests that the main impact of the lack of data was the disruption of familiar market routines rather than a fundamental problem for analysis.
• At 23:58 - "The problem is, and you kind of highlighted it, the past is not always the same... what's happening now, things can shift." - Katy Kaminski explains the core issue with relying too heavily on historical data for future predictions.
• At 24:47 - "I think the best approach is really to kind of combine different methods with different assumptions and sort of aggregate those over time, and that should be the most diversified in terms of school of thought." - Katy Kaminski advocates for diversifying not just assets, but the very models and philosophies used to invest.
• At 28:39 - "Liberation Day was actually three days in a row... a three-day in a row magnitude surprise... That has never happened in the data that I have examined, looking at, you know, lots of years of data." - Katy Kaminski describes an unprecedented market event that challenges existing models and backtests.
• At 34:35 - "If you stepped back and perhaps followed the fundamentals and looked at sort of what the overall themes of the economy were... you might have sifted through some of that noise." - Katy Kaminski suggests that in a headline-driven market with erratic price movements, a macro or fundamental approach could have provided a clearer signal than pure price trends.
• At 42:55 - "It talks about how... some of these consultants or financial firms were essentially thinking of alternatives becoming the core, not the alternative in a portfolio." - Niels Kaastrup-Larsen highlights a major potential shift in portfolio construction, driven by the growing adoption of alternative investments.
• At 44:48 - "How do the fiduciaries get away with having no allocation to trend or 1% allocation to trend? ...it's very hard to objectively argue that it doesn't add value to a portfolio." - Niels Kaastrup-Larsen questions the fiduciary responsibility of advisors who ignore the well-documented diversification benefits of strategies like trend following.

Takeaways

• Critically evaluate your reliance on frequent economic data releases and focus on identifying more robust, long-term signals instead of reacting to short-term noise.
• Build a more resilient portfolio by diversifying not just across assets, but also across investment methodologies and underlying assumptions (e.g., combining trend, macro, and fundamental approaches).
• Acknowledge that historical backtests have limits and prepare for unprecedented market events by incorporating strategies designed to perform well during periods of high uncertainty and stress.
• Re-evaluate the role of alternatives in your portfolio, considering a shift from a small, satellite allocation to a more significant, core position for improved risk management and diversification.
• Fiduciaries and advisors should objectively assess the inclusion of diversifying strategies like trend following and managed futures, as omitting them can be difficult to justify from a portfolio construction standpoint.