financial-risk-management

MacroVar Investing & Trading Guide
This guide was created by MacroVar’s team of professional fund managers and economists to enable you understand the principles of trading and investing.

Macrovar uses a top down framework to analyse markets and economies and multi-factor models to identify trading opportunities across 1,400 financial assets.

Top-Down Analysis of Markets & Economies
Fund managers use a top down framework to analyze the major components driving the global economy which in turn drive all financial markets.
The major factors monitored and analysed are:

• Global Economic growth & Inflation outlook
• Global Liquidity conditions
• Global Risk conditions
• Major Markets Price Dynamics
• Statistical Multi-Factor Models
• Country specific Macroeconomic & Market Analysis
• MacroVar Models

Global Economic Growth Expectations
The most important factor to predict from a fundamental point is view is global economic growth trend for the next one to three months. This is accomplished by monitoring leading macroeconomic indicators for each country like manufacturing, services PMI and other business and consumer confidence indicators. Global economic growth is monitored by calculating MacroVar Global PMI based on each country’s manufacturing PMI and it’s relative weight to Global GDP of the 35 largest economies. Special attention is given to the top four largest economies (United States, Eurozone, China, Japan) comprising more than 50% of global GDP. Global macroeconomic growth breadth is monitored. The trend and momentum for each macroeconomic indicator is calculated using the following metrics.
Check the major macroeconomic indicators of the largest 35 economies in the world in MacroVar’s Global Economy section.

Global Liquidity conditions
Global liquidity is a major factor affecting all financial markets. The most important liquidity factors are related to the four largest central banks in the world namely the Federal Reserve (US), ECB (Eurozone), PBoC (China) and BOJ (China). MacroVar monitors each central bank’s interest rates, Money Supply (M2) and Balance Sheet dynamics on a year to year basis.

Global Financial Risk levels
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 risk index is used for adjusting portfolio risk. MacroVar risk management provides free current risk analysis.

Global Financial Markets Overview
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: MSCI All Country World Index
• US Stocks: S&P 500 Index
• European Stocks: Eurostoxx 600 Index

Bonds

• US 10-year Treasury
• German 10-year Bund
• US Short-Term Yield Curve (2s5s)
• US Long-Term Yield Curve (2s10s)

Currencies

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

Commodities

• Crude Oil
• Copper
• Gold

Equity Risk

• US Stock implied volatility: VIX Index, VIX term structure
• EU Stock implied volatility: VSTOXX Index, VSTOXX term structure
• Emerging Markets Stock implied volatility: VXEEM Index

Credit Risk

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

Global Macroeconomic Overview

• Global Manufacturing PMI
• Global Services PMI
• Developed Economies Manufacturing PMI
• Emerging Economies Manufacturing PMI

How Financial Markets Work
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: US VIX & Europe VSTOXX falling
• Credit Risk: US CDX IG, Europe ITRAXX IG, US BofA High Yield credit spreads falling
• Volatility Term Structures: US VIX & Europe VSTOXX term structures in steep Contango
• MacroVar Risk index: falling

Stocks

• Global Stocks: rising (ideally this should occur with global bond market weakness)
• US Stocks Breadth: rising
• Global Stock Breadth: rising
• Emerging Market Stocks: rising (often outperforming developed markets like US & EU)

Stock Sectors

• Cyclical vs Defensive sectors: Cyclical sectors outperform Defensive sectors
• Sector Breadth rising

Bonds (MacroVar monitors 2-year, 5-year and 10-year bonds)

• Low Risk Bonds: US Treasuries & German Bunds falling (yields rising)
• High Risk Bonds: US High Yield Bonds, Europe Club Med Bonds, Emerging Market bonds rising (yields falling)
• Bond interest rates breadth: Rising – Funds move out of bonds into stocks hence yield rates rise

Yield Curve dynamics

• Yield Curve: Bear steepening (on the contrary a Yield Curve bull re-steepening signifies Risk Off environment)
• Global Yield Curve Steepening breadth: rising
• Fed Funds futures: steep Contango
• Eurodollar futures: Rising

Currencies

• US Dollar (DXY): Rising
• Low Risk Currencies (JPY, CHF): Falling
• High Risk Currencies (AUD, NZD, CAD): Rising
• Currencies Breadth (vs the US Dollar): Rising

Commodities

• Energy (Crude Oil): Rising
• Metals (Copper): Rising
• Low Risk Commodities (Gold): Falling
• Cyclical Commodities : Rising

Macroeconomic Conditions

• Global Manufacturing & Services trend and momentum: Rising
• Global Manufacturing & Services breadth trend and momentum: Rising

Factors of a specific financial asset
Financial assets like stocks, bonds, currencies and commodities are linked with other
related financial markets. MacroVar monitors a broad list of macroeconomic and financial factors affecting every financial market. Check a representative list of factors monitored below:

• Global Manufacturing PMI vs Global Stock Index, US Dollar, Emerging Markets, US 10-year treasury
• Stocks markets, sectors and industries versus their respective credit indices
• A specific country’s stock market vs its yield curve, Manufacturing & Services PMI, 10-year bond, Yield Curve
• Commodity Futures vs Commodities ETF

Country Macroeconomic Overview
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.
Economic Aim
A nation’s economy is healthy when it experiences stable economic growth with low inflation and low unemployment. Economic growth is measured by Real GDP and inflation by CPI, PPI. An economy is affected by its individual performance and its economic performance relative to the rest of the World (RoW).
Policymakers (government & central bank) use fiscal and monetary policy to inject liquidity (print & spend money) during slowdowns (to solve weak economic growth) and withdraw liquidity (buy back money & stop spending money) from an overheating economy (to solve high inflation).
Excessive intervention in the economy may lead to loss of confidence in the country and a financial crisis. The degree of intervention depends on the country’s fundamentals. Read how to analyze a country’s economic in depth.
The four economic environments
Financial markets are affected by economic growth and inflation expectations. The performance of each financial asset for each economic environment is explained below.

The four economic environments:

• Inflation boom: Accelerating Economic growth with Rising inflation
• Stagflation: Slowing Economic Growth with Rising Inflation
• Disinflation boom: Accelerating Economic growth with Slowing Inflation
• Deflation Bust: Slowing Economic Growth with Falling Inflation

MacroVar uses leading economic indicators for each country to predict economic and inflation expectations. More specifically for each country the Price Expectations and New Orders expectations components of the PMI, ISM and ESI indicators are used for structuring the models.

Country Macroeconomic Analysis
This analysis is based on the work of Ray Dalio and more specifically how the economic machine works.

Introduction: An economy is the sum of the transactions that make it up. A country’s economy is comprised of the public and private sector. The private sector is comprised of businesses and consumers.

Economic activity is driven by 1. Productivity growth (GDP growth 2% per year due knowledge increase), 2. the Long-term debt cycle (50-75 years), 3. the business cycle (5-8 years). Credit (promise to pay) is driven by the debt cycle. If credit is used to purchase productive resources, it helps economic growth and income. If credit is used for consumption it has no added value

Money and Credit: Economic transactions are filled with either money or credit (promise to pay). The availability of credit is determined by the country’s central bank. Credit used to purchase productive resources generating sufficient income to service the debt, helps economic growth and income.

Country versus Rest of the World: A country’s finances consist of a simple income statement (revenue–expenses) and a balance sheet (assets–liabilities). Exports are imports are the main revenue and expense for countries. Uncompetitive economies have negative net income (imports higher than exports), which is financed by either savings (FX & Gold reserves) or rising debt (owed to exporters).

Debt: A nation’s debt is categorized as local currency debt and FX debt. Local debt is manageable since a country’s central bank can print money and repay it. FX debt is controlled by foreign central banks hence it is difficult to be repaid. For example. Turkey has US dollar denominated debt. Only the US central bank (the Federal Reserve), can print US dollars hence FX debt is out of Turkey’s control.
A country can control its debt by either: 1. Inflate it away, 2. Restructure, 3. Default. The US aims to keep nominal GDP growth above interest rates (kept low) to gradually reduce its debt.

Injections & Withdrawals
The government and central bank use fiscal and monetary policies to inject liquidity during slowdowns to boost growth and withdraw liquidity from an overheating economy to control rising inflation. The available policies and tools used during recessions are the following:

Monetary Policies (MP)

1. Reduce short-term interest rates > Boost Economic growth by 1. Raising Credit, Easing Debt service
2. Print money > purchase financial assets > force investors to take more risk & create wealth effect
3. Print Money > purchase new debt issued to finance Gov. deficits when no local or foreign investors

Fiscal Policies (FP)
Expansionary FP is when government spends more than tax received to boost economic growth. This is financed by issuing new debt financed by 1. domestic or foreign investors or 2. CB money printing

Currency vs Injections & Withdrawals and inflation
The degree of economic intervention depends on the country’s economic fundamentals, its currency status and credibility. Countries with reserve currencies or strong fundamentals are allowed by markets to intervene. However, when nations with weak economic fundamentals intervene heavily, confidence is lost, causing a capital flight out of the country, spiking inflation and interest rates which lead to a severe recession, political and social crisis.

Reserve vs Non-reserve currencies: Reserve currencies are used by countries and corporations to borrow funds, store wealth and for international transactions (buy commodities). They are considered low risk. The US dollar is the world’s largest reserve currency. The main advantage of reserve currency nations is their ability to borrow (issue debt) on their own currency. These countries have increased power to conduct monetary and fiscal policies to boost their economies. However, prolonged expansionary fiscal and monetary policies eventually lead to loss of confidence in these currencies as a store of value and potential inflationary crisis.

Non-reserve currency countries: Conversely, developing nations are not considered low risk hence their ability to borrow in their own currencies is limited. Their economic growth is dependent on foreign capital inflows denominated in foreign currencies like the US dollar. During periods of global economic growth, capital flows from developed markets into developing nations looking for higher returns. These economies and their corporations’ issue foreign debt to grow. However, during periods of weak global economic growth or financial stress, foreign capital flows (also called capital flight) back to developed countries causing an inability of countries and companies to repay their debt. Central banks gather foreign exchange reserves during growth periods to create a cushion against capital outflows.

A nation’s economy is vulnerable to economic weakness or financial stress when it experiences:

• Current account deficit: a current account deficit indicates an uncompetitive economy which relies on foreign capital to sustain its spending. Hence, is vulnerable to capital outflows
• Government deficit: a big government deficit indicates an economy relying or rising debt to finance its operations
• Debt/GDP: a high Debt/GDP pushes a nation to borrow large amounts to finance its debt, print money or default. Historically, Debt/GDP higher than 100% is a red warning for economies.
• Low or no foreign exchange reserves: Developing economies are vulnerable to capital flight since foreign exchange reserves provide a cushion against capital outflows
• High external debt: Nations are vulnerable to high external debts which may be caused by a sudden depreciation of their currency or rising foreign interest rates (due to foreign growth)
• Negative real interest rates: Lower interest rates than inflation, are not compensating lenders for holding a nation’s debt hence making nation’s currency vulnerable to capital outflows.
• A history of high inflation and negative total returns:: Nations with bad history have lack of trust in value of their currency and debt

Trend & Momentum indicators
Momentum trading is used to capture moves in shorter timeframes than trends. Momentum is the relative change occurring in markets. Relative change is different to a trend. A long-term trend can be up but the short-term momentum of a specific market can be 0.
If a market moves down and then moves up and then moves back down the net relative change in price is 0. That means momentum is 0.
A short-term positive momentum, with a long-term downtrend results in markets with no momentum.
MacroVar Momentum model for Financial Markets
MacroVar Trend signal ranges from -100 to +100. The market trend signal is derived as the mean value from 4 calculations for each asset. The timeframes monitored are the following: 1 Day (1 trading day), 1 Week (5 trading days), 1 Month (20 trading days), 3 Months (60 trading days)
For each timeframe, the following calculations are performed: 1. Calculations of the return for the specific timeframe, 2. If return calculated is higher than 0, signal value 1 else signal value -1. Finally, the 4 values are aggregated daily.

MacroVar Trend model for Financial Markets
The most important trend indicator
The 52-week simple moving average and its slope are the most important indicators defining a market’s trend. An uptrend is characterized by price above the 52-week moving average followed by an upward slope. If fundamentals of the market have not changed and the moving average slope is still in uptrend, a price drop signifies a market correction and not a change of trend. Traders should watch oscillators like MacroVar oscillator and RSI to buy the dip and still follow the trend. The moving average slope turn signifies a change of trend.
MacroVar Trend model for financial markets
MacroVar Trend signal ranges from -100 to +100. The market trend signal is derived as the mean value from 8 calculations for each asset. The timeframes monitored are the following: 1-month (20 trading days), 3-months (60 trading days), 6-months (125 trading days), 1-year (250 trading days)
For each timeframe, the following calculations are performed: 1. Closing price vs moving average (MA): if price greater than MA value is +1, else -1, 2. Moving average slope: if current MA is higher than previous MA, upward slope +1, else -1
MacroVar trend model can be used as a trend strength indicator. MacroVar trend strength values ranging between +75 and +100 or -75 and -100 show strong trend strength.
A technical rollover is identified when MacroVar trend strength indicator moves from positive to negative value or vice-versa.

MacroVar Trend model for Macroeconomic Indicators
A macroeconomic indicator is in an uptrend when last value is higher than its twelve month moving average and its twelve month moving average slope is positive (last twelve month moving average is higher than the previous month’s twelve month moving average)
Lastly, MacroVar calculates the number of months the current value has recorded highs or lows. Trend change is assumed when a specific indicator has recorded a 3-month high / low or more.
MacroVar Momentum model for Macroeconomic Indicators
A macroeconomic indicator’s momentum is monitored by calculating its long-term year over year (Y/Y) return and its short-term month on month (M/M) return.

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