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"Minsky Phases" Asset Allocation

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  • Based on Hyman Minsky’s research : Financial crises are not a succession of booms and bust in a straight line but are occurring following a loop pattern. Consequence : crisis and expansions are both expected and unavoidable, being the consequence of each other
  • Employment is typically the most important macroeconomic data for the markets because it is released with a short lag and is full of important new information on the broad economy as well as individual sectors.
  • Employment is typically the most important macroeconomic data for the markets because it is released with a short lag and is full of important new information on the broad economy as well as individual sectors.
  • Employment is typically the most important macroeconomic data for the markets because it is released with a short lag and is full of important new information on the broad economy as well as individual sectors.
  • Employment is typically the most important macroeconomic data for the markets because it is released with a short lag and is full of important new information on the broad economy as well as individual sectors.
  • Employment is typically the most important macroeconomic data for the markets because it is released with a short lag and is full of important new information on the broad economy as well as individual sectors.
  • Transcript

    • 1. Etienne Hannart - Nicolas Paris
      “Minsky phases”
      a Tactical Asset Allocation model
    • 2. Essential Minskyidea
      Financial crises are not a succession of booms and bust in a straight line but are occurring following a loop pattern.
    • 3. Debt markets are smarter than equity markets
      Momentum Works
      Economic data matters : it has a predictive power
      Other main assumptions
    • 4. The Minsky Phases or the loopprocess
      Beta hunting
      Asset boom
      Inflation
      Minsky Moment
      Ponzi Phase
      Speculative Phase
      Seeking Alpha
      Creditexpansion
      CRASH
      Comfort Phase
      Comfort Phase
      Looking for safe and reasonnableyields
      Financial Innovation vs new regulations
    • 5. Identifying the ‘Minsky Moment’
    • 6.
    • 7. Model Logic
      Spottingpotential ‘Minsky Moments’
      II) If one isseencoming :
      A) First, getout of RiskAssets
      B) Then, assessthe magnitude of the coming crash – Shouldwe short or not ?
      III) If short RiskAssets, need to find the best point to cover shorts and go long
    • 8. Indicators
      detailed
      Indicators
      detailed
    • 9. Model Logic
      Recession Warning
      II) Short or Not ?
      III) RecoveryIndicator
    • 10. I. Recession Warning 1 : CreditSpread
      Rationale
      • An InvertedYieldCurveis a badomen
      • 11. Lendersare showingthatthey have no confidence in borrowers
      • 12. Minsky« Ponzi Phase » approaching
      Our Approach
      • Follow the spreadof 10y US T-Bonds and 3m US T-Bills
    • I. Recession Warning 1 : CreditSpread
    • 13. I. Recession Warning 2 : MonetaryGrowth
      Rationale
      • Money Supplygrowthacts as a proxy of money availability
      • 14. Second component of « Minksy moment »
      • 15. Money must beexpensive AND scarce
      • 16. Negativemonetarygrowth shows credit destruction
      Our Approach
      • Wewait for a negative CPI adjustedmonetarygrowth
    • I. Recession Warning 2 : MonetaryGrowth
    • 17. I. Recession Warning : Combinedsignals
      If the twoindicatorsgivesignals on the samemonth, weget a «Recession Warning».
      As we have simultaneoussignals, weconsider the recession warning received to bestrong, soweextendit over the following2 quarters.
      Recession Warning  SellEquities, Buy T-Bills
    • 18. I. RecessionWarning
      No false positives, no recessionsmissedafter 1962.
      00’s one isspotted a tadtoolate
      SellEquities, Buy T-Bills
    • 19. Model Logic
      Recession Warning
      II) Short or Not ?
      III) RecoveryIndicator
    • 20. II. Short the Recession ?
      Rationale
      • For precise timing, listen to markets
      • 21. Debtmarkets are smarterthanEquitymarkets
      • 22. Momentum has a predictivepower
      Our Approach
      • We compare the momentum of
      • 23. S&P-500
      • 24. US T – 10y
    • II. Relative Strength - Results
      Interpreting the indicatorisvery simple : if it shows that bonds are strongerthanequitiesduring a recession warning, then the model sells short the S&P-500.
      All othersignals are ignored.
      Bond relative strength
      Sell Short Equities, Hold T-Bills
    • 25. II. Relative Strength - Results
      Many false positives, all filtered by the recession warnings.
      Mildrecessions do not trigger shorts
      Final Project
      IE Business School
      December 9, 2010 – xx/yy
    • 26. Model Logic
      Recession Warning
      II) Short or Not ?
      III) RecoveryIndicator
    • 27. III. UnemploymentGrowth
      Rationale
      • Unemploymentis the most important macroeconomic data for the markets
      • 28. Tightrelationshipbetweenrecessionthrough and peak in new claims for unemploymentinsurance (Robert Gordon)
      Our Approach
      • Use the smoothedslope of unemployment, pinpointingits reversal
    • III. UnemploymentGrowth
      The slope reversal alwayshappensbetween the middle and the end of the recession
    • 29. III. IndustrialSupply Management (ISM)
      Rationale
      • Encompassesmost of the real economy (employment, inventories, new orders)
      • 30. Widelyfollowed
      • 31. Serves as a confirmation of theemploymentsignal
      2. Ourapproach
      • The ISM gives a verynoisysignal, so we use a simple systembasedontwotresholds :
      • 32. Onefarbelow (“So badthatit has togetbetter”)
      • 33. Oneabove (“Alreadyrecovering”)
    • III. Combinedsignals
      Whenboththeunemploymentrate and the ISM index are providing a positive signal, wegolongequitiesagain.
      RecoveryIndicator Signal 
      Cover Shorts / Long Equities
    • 34. III. Combinedsignals
      All short positions profitable, exceptthefirstone (1970)
    • 35. Performance Review
      DecisionProcess
      Algorithm
    • 36. Algorithm – a Loopprocess (1)
      10y/3m spread
      YES
      Recession Warning
      SELL Equities
      BUY T-Bills
      CreditGrowth
      YES
      This month & next 6 months
    • 37. Algorithm – a Loopprocess (2)
      10y/3m spread
      YES
      Recession Warning
      SELL Equities
      BUY T-Bills
      CreditGrowth
      YES
      This month & next 6 months
      Relative Strength
      Recession Warning
      SELL T-Bills
      NO
      YES
      HOLD T-Bills
      SELL Equities Short
      BUY Equities
    • 38. Algorithm – a Loopprocess (3)
      10y/3m spread
      YES
      Recession Warning
      SELL Equities
      BUY T-Bills
      CreditGrowth
      YES
      This month & next 6 months
      Relative Strength
      Recession Warning
      SELL T-Bills
      NO
      YES
      Unemployment
      Growth
      YES
      HOLD T-Bills
      SELL Equities Short
      BUY Equities
      ISM
      YES
    • 39. Performance Review
      Leverage
    • 40. Leverage (1/2)
      Leverageisdangerousbecauseitmakes a portfoliovulnerable to quick drop in equitiesprices.
      However the main purpose of our model is to limitexposuretowardsthis type of events.
      And itdoesavoidmostrecessions
      Thereforeitisadapted to leverage
    • 41. Leverage (2/2)
      Use of leveragewhen E(Rm) > cost of funding
      E(Rm) defined by CAGR of S&P 500 from 1950 to currentmonth.
      Cost of funding = Risk free rate + 100 bps
      Usedbothwhen long and short
      Weuse a conservative level of leverage of 1.3:1 (The factthat the model has predictedpastrecessionsuccesfullyis not a guarantee..)
    • 42. Performance Review
      Performance
      Review
    • 43. Performance
    • 44. Decisions& Performance
    • 45. Closer look at main recessions
    • 46. Limits
      Limits
    • 47. Guidelines / Methodology
      Traps of backtesting
      Thresholddependancy
      Use of monthlyreturns
      Our approach
      A rationale for eachindicator
      A rationale for eachthresholdnumber
      Using round numbers
      Rulescanbeexplained in plain english
      Objective
      Give to potentialusers the confidence to follow the system’srecommendations
    • 48. Robustness / Tresholddependancy
      Recession Warnings
      Intrisicalyrobust, as itdoes
      Weak to one parameter : number of months of ‘pushingforward’ the recession warning.
      Reducingitpunishes the results (quitelogically)
      Increasingittoo (less acceptable)
      Many solutions available, but stillwondering over the mostintellectuallysatisfying (ratherthan the most profitable)
      Short or not
      Parameters changes : robust
      Weakness : Interaction withRecession Warnings
      Recoveryindicator
      Parameters changes : veryrobust
      No changes needed