Top Down approach

The top down approach in portfolio management seeks to analyse the major components driving the global economy which ultimately drives all financial markets. The most important task of a trader is to predict where market will be in 6-12 months ahead.

The major components of the top down approach are:

1. Global Economic Growth Analysis
2. Global Inflation outlook
3. Global liquidity conditions Analysis
4. Global Risk environment Analysis
5. Major financial assets Performance
6. Factor analysis
7. Portfolio & Risk Management Tools

Global Economic Growth Analysis

The most important factor to monitor is global economic growth trends and momentum. Individual country economic growth expectations are gauged using principally each country’s Manufacturing PMI and other business and consumer confidence indicators. Global growth is gauged by calculating MacroVar Global PMI based on each country’s weighting to Global GDP of the 35 largest economies monitored and Manufacturing PMI. Special attention is given to the top four largest economies (United States, Eurozone, China, Japan) comprising more than 50% of global GDP. Lastly, global macroeconomic growth breadth is monitored. MacroVar uses the following signals to analyse Macro trends

The Global Economy section presents the current global macroeconomic conditions using different statistics. The largest four economies in the world closely monitored are the US, Eurozone, China and Japan economies comprising more than 50% of Global GDP. MacroVar also monitors the relative performance of Developed and Emerging economies.

Global Liquidity conditions

Global liquidity is a major factor affecting all financial markets. It is of paramount importance to monitor Global Liquidity of the four major central banks in the world namely the Federal Reserve (US), ECB (Eurozone), PBoC (China) and BOJ (China).

MacroVar monitors central banks actions by closely monitoring published statistics and news flow.

The Central Banks section presents quantitative data and news flow for the four major central banks and secondarily to the rest of the 31 countries monitored.

Global Risk

Global financial risk conditions are especially important since they affect all financial assets. MacroVar risk index is composed of various financial risk factors to provide an overview of global market risk conditions.

The major risk components monitored are:

1. Equity Risk: (Major Indicators: VIX, VSTOXX)
2. Credit Risk (Major Indicators: US CDX IG, US CDX HY, EU ITRAXX, CDX Emerging Markets, IBOXX US IG, IBOXX US Banks Senior, IBOXX EU IG, IBOXX EU Banks Senior)

Other risk components monitored by MacroVar Risk index are the following:

1. Equity Risk
2. Credit Risk
3. Liquidity Risk
4. Corporate Credit Risk
5. Emerging Market Risk
6. Global Bank Risk
7. Sovereign Risk
8. Currencies Risk
9. Commodities Risk

The risk index is used for adjusting portfolio risk. MacroVar risk management section provides free current risk analysis.

Global Financial Assets

MacroVar uses a top down framework to analyse financial markets as well. The major financial markets which affect the rest of the other financial assets are:

Stocks

• Global Stocks: ACWI
• US Stocks: S&P 500
• EU Stocks: EuroStoxx

Bonds

• US 10-year treasury rate: US10Y
• German bund rate: DE10Y
• US Short-term Yield Curve: US2s5s
• US Long-term Yield Curve: US2s10s

Currencies

• US Dollar Index: DXY
• Risk Off Currencies: USDJPY, USDCHF
• Emerging Market Currencies: CEW

Commodities

• Crude Oil
• Copper
• Gold

Equity Risk

• US Volatility: VIX, VIX Term structure
• EU Volatility: VSTOXX
• Emerging Market Volatility: VXEEM

Credit Risk

• US Corporate Risk: CDX IG, CDX HY
• EU Corporate Risk: ITRAXX EU
• Emerging Corporate Risk: CDX EEM

Global Macro

• Global PMI
• Developed Economies
• Emerging Markets

Financial Assets Logic

The basic logic on how financial assets behaves during different economic conditions is provided below. There are periods where correlations between financial assets breakdown and where economic data are disconnected from financial markets but the core market logic is described below.

There are two market environments: Risk On periods during which funds flow from safe assets to risky assets and Risk Off periods where funds flow from risky assets to low-risk assets.

Risk Assets (Risk-On): Stocks, Cyclical Commodities, Cyclical Sectors / Industries, High Yield Bonds, Cyclical Currencies, Emerging Markets (Capital flows to emerging markets in search for higher yields, higher growth rates and hence profits)

Safe Assets (Risk-Off): US Treasuries, German Bunds, Defensive Sectors / Industries, US Dollar DXY, Swiss Franc, Japanese Yen, Gold

The most important asset correlation is between the US stocks and US Bonds. During risk on periods US stocks rise while US bonds are sold and vice-versa. Since equities are closely linked with credit, MacroVar monitors closely the performance of corporate bonds for each sector in US and EU markets.

During Risk on Periods the markets behave as follows:

• Global Risk
  • Equity Risk (VIX, VSTOXX): falling
  • Credit Risk (CDX IG, ITRAXX IG, BofA High Yield credit spreads): falling
  • Volatility Term Structure: steep contango
  • MacroVar Risk Index: falling
  • MacroVar Risk On/Off monitor Ratios: falling
• Stocks
  • Global Stocks rising (ideally this should occur with global bond market weakness)
  • US Stock Breadth rising
  • Emerging Market Stocks rising (often outperforming developed markets like US & EU)
  • Global Stock Breadth rising
• Stock Sectors
  • Cyclical sectors outperform Defensive sectors
  • Sector breadth rising
• Bonds (MacroVar monitors 2-year, 5-year and 10-year bonds)
  • Safe Bonds
    • US Treasuries falling (yields rising)
    • German Bunds falling (yields rising)
  • Risky Bonds
    • US High Yield Bonds rising (yields falling)
    • Europe: Club Med Bonds rising (yields falling)
    • Emerging Markets Bonds rising (yields falling)
  • Bond interest rates breadth rising (funds move out of bonds into stocks hence yield rates rise)
• Yield Curve
  • Yield Curve Bear steepening (on the contrary a Yield Curve bull re-steepening signifies Risk Off environment)
  • Fed Funds futures above US 2-year bonds implying strong economic growth and FED hawkish stance
  • Yield Curve Steepening Breadth rising
  • Eurodollar Futures rising
• Currencies
  • US Dollar (DXY) falling
  • Safe Currencies (JPY, CHF) falling
  • Risky Currencies (AUD, NZD, CAD) rising
  • Currencies Breadth (vs the US Dollar) rising
• Commodities
  • Energy (Crude Oil) rising
  • Metals (Copper) rising
  • Safe commodities (Gold) falling
  • Commodities Breadth rising
• Macroeconomic Conditions
  • Global PMI trend and momentum rising
  • Global PMI breadth monitored strong

MacroVar World Markets section is an overview of the major financial markets monitored. Click any of the financial assets to examine the signals of the factors affecting it as well as the asset’s trend, momentum and different statistics monitored.

Country Analysis

MacroVar analyses the economic and financial conditions of the largest 35 economies in the world by monitoring 40 economic and financial indicators for each country.

Country Economic Snapshot

Real economic growth expectations and the inflation outlook of the global economy drive all financial assets. Business confidence and consumer confidence are the major leading indicators predicting a country’s economic growth. When a country’s macroeconomic conditions are dire and there is no possibility of fiscal or monetary stimuli, investors should look to sell rallies and vice-versa.

Countries’ policy makers aim to achieve sustainable economic growth with low unemployment and low inflation. They closely monitor current economic conditions and react accordingly either providing liquidity to the economy to speed up economic activity or recovery or removing liquidity.

Portfolio managers main task is to predict future economic conditions and front run policy makers actions (central banks, governments) by analysing leading market and macroeconomic indicators.

The four economic environments

There are 4 economic environments based on economic growth and inflationary conditions.

Financial assets are affected by economic growth and inflation expectations. The performance of each financial asset for each economic environment is explained below.

• Inflation boom: Accelerating Economic growth with Rising inflation

The best performers are emerging market stocks, international real estate, emerging countries’ currencies, commodities, and TIPS (treasury inflation protected securities).

The worst performers are US treasury bonds and cash since they are adversely affected by rising inflation.

High global growth with rising inflation expectations lifts commodities. Many emerging economies growth is linked to commodities. When commodities rise emerging market stocks, currencies and real estate rise as well.

• Stagflation: Slowing Economic Growth with Rising Inflation

Click to check the Best & Worst Assets during Stagflation

The best asset performers protecting investors from inflation are Gold, Cash, Treasury Inflation Protected Securities, and the US Dollar.

The worst performers are long-duration treasury bonds adversely affected by rising inflation.

• Disinflation boom: Accelerating Economic growth with Slowing Inflation

The best performers are developed markets stocks, developed Real estate and US Treasury bonds.

Low inflation with moderate growth is a good environment for bonds and stocks and bad for the worst performs which are commodities and commodity related sectors.

• Deflation Bust: Slowing Economic Growth with Falling Inflation

During this environment the best asset performers are Long-Duration Treasuries and Cash. Everything else experiences big volatility and often large losses.

During crashes and economic depressions bonds rise while stocks and commodities fall. Investors during these environments look for the safety of their asset rushing into the safety of US treasury bonds and the US dollar while selling stocks and commodities.

MacroVar simpler model monitors the dynamics of Manufacturing PMI as the leading economic indicator to monitor economic conditions. The absolute value and YoY (Momentum) of manufacturing PMI is used to gauge a country’s economic conditions.

MacroVar uses leading economic indicators for each country to predict economic and inflation expectations. More specifically, US ISM PMI components and ESI components for all European countries and the Eurozone are used for structuring this model.

MacroVar also provides a detailed analysis of a country’s economy by analysing more than 30 indicators for each country. Read more about analysing a country’s macroeconomics in detail.