"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.
  • "Minsky Phases" Asset Allocation

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

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