Keep Your Eye On The Charts
- Active asset allocation and a “go-anywhere” strategy are important tools to achieve return objectives in markets like the one we’re in now.
- According to Topdown Charts, author of Weekly Best Idea on SA Marketplace: “Trade what you see, not what you want to see.” Chart-driven investing is a way to efficiently assimilate a lot of information and spot opportunities..
- Gold is on borrowed time. Read on to find out why Topdown Charts thinks so.
Type the key words “chart driven investing” into Google search, and Seeking Alpha author Topdown Charts comes up as the No. 2 hit. He’s an independent, chart-driven investor with a global bent, and he seeks opportunities the world over for hedge funds, family offices, insurers, wealth managers and investment consultants. He believes his macro-oriented, “go-anywhere” approach allows him to cast a wide net, leaving no shell unturned, which opens a vast universe of profit potential.
He’s also the author of Weekly Best Idea on Seeking Alpha’s Marketplace, where he provides in-depth research guided by three principles: valuation, cycle and tactics. You can find out more about that here, but suffice to say, it’s not a stock-picking service, and his ideas and research span geography and sectors. So, in a sense, he views the world as an investor’s oyster. He joined the Roundtable to talk about his global, active asset allocation approach; why he believes chart-watching is the best way to discover hidden opportunities; and why he thinks gold is seriously overvalued.
Seeking Alpha: You tout Weekly Best Idea as a service for “active asset allocators with a go-anywhere, global approach.” For those unfamiliar with “active asset allocation” strategies, what does that mean, and how can investors benefit from this type of approach?
Topdown Charts: Really good question. At the simplest level asset allocation is about getting the mix of assets (e.g., stocks, bonds, cash, and alternatives) “right” given a certain set of objectives and constraints. The biggest question to get right in asset allocation is the mix between defensive and growth assets… which is to say maximizing exposure to growth assets, i.e., stocks, during a bull market, and maximizing holdings of cash/fixed income or other defensive assets heading into a bear market.
Some investors will take a “set-and-forget” approach to the mix of assets in their portfolio, but many will look to change allocations through the cycle (adjusting allocations to growth vs. defensive assets). Some will opt to focus on the ‘waves vs. tides’ (the waves = short-term fluctuations in markets, the tides = longer term and larger scale trend changes, i.e., bull markets vs. bear markets).
Aside from time frame, the other key parameter that differentiates investors is how granular they go within and across asset classes. Many investors go straight down to the stock level, picking and choosing individual securities. Yet there exists a class of investor, today empowered by the rise of ETFs and other products, who focuses on allocations beyond the big buckets of stocks and bonds, to individual countries, regions, sectors, styles, commodities, currencies, etc.
The big attraction is that skilled portfolio managers with a solid process and research capability can successfully employ a top-down approach to active asset allocation on a sector/region/country basis. Aside from the big opportunity to add value over the long run in navigating bear vs. bull markets, taking a more active, go-anywhere approach gives access to a greater opportunity set through the cycle. And in markets like this, such an approach can sometimes be the only way to really achieve return objectives.
SA: Your research is very chart-driven, obviously. What are you looking for in the charts you study? How did you come to arrive at your preference for chart- and data-driven investing? What are the benefits to investing this way, in your opinion?
TC: I’m a strong proponent of the axiom “trade what you see, not what you want to see.” This refers to erring on the side of facts vs. forecasts. The best chart example of this I can think of is the way betting markets were trading in 2016; pricing less than a 10% probability of a Republican President, while Trump’s average polling was around the mid-40s… basically a bit closer to 40-50% vs. the market pricing of 10%. My aim is to look for opportunities like this (e.g., where the market is priced to pay 10:1 when the odds look closer to 2:1). Provided you have the right indicators and data, charts offer a really effective way of dealing with this challenge.
Aside from presenting a good fact-based representation of reality, charts also allow you to assimilate information at a rapid pace. I’m not sure what the exact numbers are but the human brain can process images multiples of time faster than it can process words… time for a another cliché – “a picture says a thousand words.” And when you’re dealing with a larger opportunity set, efficiency is important.
So it’s a matter of effectiveness as well as efficiency. This applies to me in how I do my analysis, as well as how I present the findings and insights to clients.
SA: Following on that, you incorporate a multitude of variables into your research, including technicals, valuations, earnings, monetary policy, sentiment, flows, supply cycles, and your own proprietary indicators. Putting these together holistically, what sort of picture creates an “opportunity” for you, and how do you know when is the “right time” to act on that opportunity?
TC: It depends on the asset class, but the basic model for the ideal buying opportunity is you want to see a situation where the asset is undervalued, where monetary policy is (or is becoming) supportive, where the economic cycle is turning up from recession (or supply cycle turning around, earnings cycle improving, etc.), and where sentiment/positioning indicators show the asset as ‘unloved’ and ‘oversold,’ and ideally some sort of technical catalyst and/or some background supporting thematic.
These opportunities come along once every few years, but if you expand your universe of investments to include sectors and countries, then you’re more likely to find these kinds of high conviction opportunities.
The type of setup I just described is often found at the start of a cycle (and the opposite conditions would be found at the top), but through the cycle when valuation becomes more neutral, it’s about keeping on top of the cyclical picture and monetary conditions, and trading on sentiment and technicals, because when you’re dealing with asset allocation, there’s no such thing as not having a view on markets.
My view is you don’t just want to use a hammer, you also want to use a saw, a wrench, a screwdriver… you want a toolkit that allows you to build the full picture, which in turn helps build the level of conviction - and for investors, conviction is what makes money because it determines whether you implement or not, and what kind of position you take.
SA: Fed tightening, tightening of credit spreads - in this context, you mentioned “early warning signs” in your article titled “Ted, Fed and Credit.” Briefly, what’s going on here, and why should investors be wary?
TC: I have been quite focused on US High Yield Credit for the last few months and recently featured in a report on the Weekly Best Idea dealing with some of the early warning signs starting to emerge here.
Thinking back to the previous question on analytical framework/process, the starting point is valuation and for credit spreads there’s few really good measures of valuation, but simply looking at the level of where spreads are at, it looks “expensive.” The problem with this is that you could have said the same thing back in 2004, taken a short position, and then noticed as you got steamrolled by the markets for 2-3 years until you finally got your payoff (or went broke!).
So it’s not enough to say that a market is expensive or overvalued. You have to figure out what else you need to be watching. In the case of US HY credit spreads, I am watching the following:
Economic cycle (indicators look good at the moment, albeit they almost look “too good”)
Monetary policy (in the process of going from tailwind to headwind)
Lending standards (some signs of movement, but “orange lights” - not “red lights” yet)
Credit conditions (surveys still on the positive side, lines up with economic picture)
CDS markets (bank CDS look to have bottomed, some warning signs in corporate CDS)
Sentiment (has been shaken by the broader bond market selloff, big outflows)
Relative risk pricing (big divergence between equity vs. credit risk pricing)
Seasonality (seasonality turns negative (wider) for credit spreads from late April)
My view is we have seen the bottom in credit spreads at this point, I base this on the relative risk pricing, monetary policy trend, movement in lending standards, warning signs in the CDS markets, shift in sentiment, and seasonality outlook. But what needs to fall in place before it becomes a screaming sell is the economic cycle and credit conditions picture. That could turn quickly - but more on that in the next question.
So by using multiple indicators and being agnostic to what types of information you look at you can quickly move from an observation on valuation to a more tactically meaningful view on the outlook. As for credit spreads, we’re definitely in the later innings at this stage.
SA: You’re a global and sector-agnostic investor, so presumably you can find opportunities just about anywhere. So where are you seeing opportunities, broadly?
TC: Correct. As I mentioned before, a lot of the time the “perfect setup” will only come along maybe once every 5-10 years, so by expanding the universe of asset classes that you look at, you’re more likely to find one of these opportunities. And while there is increased cross-correlation across asset markets these days, there is still space for idiosyncratic moves across asset classes, and what’s more, they often go through cycles. The typical experience is that stocks do best in the early part of the cycle, then commodities and property do better, and then when it rolls over bonds and cash do better, (and repeat).
In terms of where I see opportunities at the moment, in a broad sense there are three things:
Relative Value: Looking at global equities, US equities are clearly expensive, but emerging markets still see relative value in aggregate, and there are definitely pockets of relative value across countries and sectors.
Tactical Yield Plays: In the wake of the bond market selloff we’re seeing some interesting tactical setups in REITs and MLPs.
Risk Management: I actually think there is more opportunity than usual at this stage of the cycle for those who have a solid risk management process and framework.
So that should give readers something to think about!
SA: It’s no secret, there’s been a lot of volatility in the markets already this year, and we’re just coming into the end of Q1. What is your outlook for the remainder of 2018, and any prognostications for 2019? Are you seeing recessionary signals?
TC: Yeah I think higher volatility is here to stay - but that doesn’t actually necessarily mean that markets go down. Given the macro/earnings backdrop remains intact, I think it’s fair to postulate that we see a repeat of the type of market we saw in the late 1990s where you had rising volatility and rising stock prices.
Going back to my initial assertion, I was telling clients late last year that volatility is likely to be higher in 2018 and market conditions/investing in general is going to become more challenging based on 3 key themes: i. increasing incidence of overvaluation across asset classes; ii. a maturing business cycle; and iii. a turning of the tides in global monetary policy.
Again, I try to avoid making grandiose forecasts like when a recession is going to start – there’s an old joke about the stock market predicting 9 of the last 5 recessions, and with some commentators it’s like they already start predicting the next recession before the first one is even over.
But as economic cycle is a key input you still need to do something, and the next best thing from forecasting is to look at the facts and keep on top of the trends in the data (why charts are so key). The other thing to look at is leading indicators, and even then old relationships can breakdown. But at the moment, I’m still seeing solid data at the global level, and particularly the US. China does concern me a little, but even that one I think will take 6-12 months to play out. So if I had to guess I would say no recession this year, and watch this space in 2019 and 2020 because all cycles come to an end, and we are in the later stages of the cycle.
SA: Not everyone is a fan of top-down macro analysis. Clearly, you take the position that macro matters. Why do you believe that, and do you believe investors who ignore macro indicators do so at their own peril?
TC: When you’re talking about active asset allocation, unless you have a purely systematic/quant approach (and even then you’re probably using top-down/macro, but within a rules-based system) there’s not really any alternative. Perhaps an exception would be someone who looks only at valuation and takes a very slow moving approach and who expects to be wrong sometimes for a number of years before being right.
But most professional active asset allocators these days take this approach just because it works and provides a greater chance of being on the right side of the market and reduces the chance of being “right at the wrong time” (e.g. in the case of investors who went underweight stocks in 1997 because valuations were expensive).
You could possibly argue that individual stock pickers, investors focused on finding the best companies, etc., or value investors, that these guys are more focused on “fundamentals” and less concerned about macro trends or market timing as such. But even then, you can’t ignore what’s going on in commodity markets, what the prevailing global macro trends are, and where we’re at in the cycle.
Like for a value investor who says I’m buying shipping companies because they have really cheap valuations, and these particular ones are well managed have good governance, etc… they might be 100% right in finding the best shipping companies, but when you add to that a view say that global trade is about to accelerate, then it provides a more well-rounded case, or gives a macro-catalyst to it.
SA: What’s one investment you think readers should steer clear of, and why?
TC: Probably going to make myself some enemies with this one, but I think gold is seriously overvalued here. As a minimum, I would say that if you wanted to own commodities there’s much better places to be long in commodities than gold, and even in precious metals the setup in silver is much more attractive relative to gold.
Specifically - and I covered the outlook for gold in the Weekly Best Idea, but here’s a snapshot - here’s why I think gold is on borrowed time:
Valuation (on a real price vs. history, and relative to other commodities gold looks expensive)
Real interest rates (real interest rates have been rising steadily and this increases the opportunity cost of holding gold, the chart in the report shows this starkly)
Monetary policy (rate cuts + QE were good for gold, so expect rate hikes and QT to be bad)
Technicals (unconvincing breakout of downtrend channel, and failure so far to break through key overhead resistance levels)
Sentiment (positive fund flows, net-long speculative futures positioning – geopolitical risk/fear probably overinflating demand for gold)
Volatility (gold implied volatility is at very low levels, smacks of complacency)
So I would be wary of those saying buy gold because it’s a hedge, when you have such headwinds, which means it may not act the way you want it to act. By contrast, silver is currently seeing a rare net-short speculative futures positioning, and in real terms is below its historical average, if you had to own precious metals, silver looks better placed relative to gold. But overall I would be looking at gold from the short side or thinking about risk management of any gold-linked exposures.
And yeah it goes to show that you need to be careful with what you think is a hedge… bonds were not a good hedge when both stocks and bonds were falling, and I could have told you that by looking at any number of factors on the macro/top-down front. So take what you see and hear with a healthy dose of skepticism and keep an eye on the charts.
Thanks to Topdown Charts for joining us on the Roundtable. To read more of his macro insights, check out his author page, and for in-depth, sector- and geography-agnostic, institutional-style research to help you make sense of the markets, consider a subscription to Weekly Best Idea.
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