WisdomTree Market Update
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May 2018
Equity Market Risk Gauge
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Correlation Signal
The VIX: A Very Widely Publicized Gauge of Risk
Source: Bloomberg.
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Tracking Pairwise Correlations has been an Interesting Signal Average Correlations in a Post QE World were at an All Time Low but Rising Recently (1 July 2008 to 31 Mar. 2018) Average Trailing 6 Month Correlations in S&P 500 PRE QE World
INTRA QE World
Nov. '07- Nov '08
Nov. '08 - Oct' '14
0.7
POST QE World Dec '14 - Onwards
Q E1
Q E2
Nov '08 - Mar '10
Nov '10 - Jun '11
Q E3 Sep '12 - Dec '13
Avg. Correlation
0.6
0.5
0.4 0.32
0.3
0.2
0.1
0 Jul-08
Jul-09
Jul-10
Jul-11
Jul-12
Jul-13
Jul-14
Jul-15
Jul-16
Jul-17
Source: Bloomberg
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Correlation Indicator Corresponded to big Drawdowns in the Market Applied to the MSCI USA Index over the period, we saw this strategy increase Average Annual Returns from 5.31% to 9.28%, and lower standard deviation from 14.05% to 11.65%. In 2008, the MSCI USA Index was down more than 38%, whereas this strategy was down 12%.
MSCI USA Index (31 Dec. 2001 to 31 Mar. 2018) Correlation Hedging Indicator 3000
1
0.8 0.7
Index Level
2000
0.6 1500
0.5 0.4
1000
0.3 0.2
500
Hedging Indicator (1=On, 0=Off)
0.9 2500
0
Dec-01 Apr-02 Aug-02 Dec-02 Apr-03 Aug-03 Dec-03 Apr-04 Aug-04 Dec-04 Apr-05 Aug-05 Dec-05 Apr-06 Aug-06 Dec-06 Apr-07 Aug-07 Dec-07 Apr-08 Aug-08 Dec-08 Apr-09 Aug-09 Dec-09 Apr-10 Aug-10 Dec-10 Apr-11 Aug-11 Dec-11 Apr-12 Aug-12 Dec-12 Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17 Aug-17 Dec-17
0.1
Hedge Signal - On/Off (Rt Axis)
0
MSCI USA Index
Source: Bloomberg. When the correlation indicator is “on” the assumption is that equity exposure in the portfolio is turned off. When the correlation indicator is “off” the assumption is that the exposure is that of the MSCI USA Index.
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Correlation Indicator can Also be Applied to Eurozone Applied to the MSCI EMU Index over the period, we saw this strategy increase Average Annual Returns from 3.70% to 9.37%, and lower standard deviation from 17.41% to 15.47%. In 2008, the MSCI USA Index was down more than 44%, whereas this strategy was down 23.5%.
MSCI EMU Index (31 Dec. 2001 to 31 Mar. 2018) 400
1
350
0.9 0.8
300 0.7 0.6
200
0.5
150
0.4
Index Level
250
0.3 100 0.2 50
0.1 Dec-01 Apr-02 Aug-02 Dec-02 Apr-03 Aug-03 Dec-03 Apr-04 Aug-04 Dec-04 Apr-05 Aug-05 Dec-05 Apr-06 Aug-06 Dec-06 Apr-07 Aug-07 Dec-07 Apr-08 Aug-08 Dec-08 Apr-09 Aug-09 Dec-09 Apr-10 Aug-10 Dec-10 Apr-11 Aug-11 Dec-11 Apr-12 Aug-12 Dec-12 Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17 Aug-17 Dec-17
0
Hedging Indicator (1=On, 0=Off)
Correlation Hedging Indicator
Hedge Signal - On/Off (Rt Axis)
0
MSCI EMU Index
Source: Bloomberg. When the correlation indicator is “on” the assumption is that equity exposure in the portfolio is turned off. When the correlation indicator is “off” the assumption is that the exposure is that of the MSCI EMU Index. Returns are measured in euros.
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U.S. Dollar Appreciation in 2017
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Expectations ≠Market Performance
U.S. Dollar Depreciation was Widespread in 2017
Source: Bloomberg.
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Policy Rate Differentials have Favoured the U.S. dollar Market Performance has Favoured the JPY & EUR
1.8
105
Policy Rate Differential (%)
1.6 100
1.4 1.2
95 1 0.8 90
0.6 0.4 0.2
0 Dec 16
Policy rate Differential (US vs. Euro Area, LHS) Policy rate Differential (US vs. Japan, LHS) USD vs. JPY (RHS) USD vs. EUR (RHS)
85
80 Mar 17
Jun 17
Cumulative Change in USD vs. JPY & EUR (based at 100)
Policy Rates and Spot Rates (31 Dec. 2016 to 1 May 2018)
Sep 17
Sources: Macrobond, Record. Spot rates are indexed to 100 in December of 2016.
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Future Rate Expectations Matter
0.2
105 103
Yield Curve Slope (%)
0.1
101 0
99 97
-0.1
95 -0.2
93 91
-0.3
89 -0.4
87
-0.5 Dec 16
85 Feb 17
Apr 17
Jun 17
Aug 17
Oct 17
yield curve slope (US vs. Euro Area, LHS)
yield curve slope (US vs. Japan, LHS)
USD vs. JPY (RHS)
USD vs. EUR (RHS)
Cumulative Change in USD vs. JPY & EUR (based at 100)
Yield Curve Slopes and Spot Rates (31 Dec. 2016 to 1 May 2018)
Sources: Macrobond, Record. Yield curve slope is measured using interbank rates. Spot rates are indexed to 100 in December of 2016.
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Valuation Analysis has Favoured U.S. Dollar Depreciation
130
U.S. Dollar Index Spot Level vs. U.S. Dollar Index Purchasing Power Parity Level (31 Jan. 1997 to 31 Mar. 2018)
120
U.S. Dollar Level
110
100
90
80
70 1997
1999
2001
2003 DXY Spot Level
2005
2007
2009
2011
2013
2015
2017
DXY Purchasing Power Parity Level
Sources: Bloomberg, Record. Based on weighting Euro Area 19 (57.6%), Japan (13.6%), United Kingdom (11.9%), Canada (9.1%), Sweden (4.2%), Switzerland (3.6%).
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Explanatory Power of Relative Growth Cycles has been Strong
1.5%
150
1.0%
140
0.5%
130
0.0% -0.5%
120
-1.0%
110
-1.5%
100
U.S. Dollar REER
U.S. vs. Rest of World Growth Differential
Relative Growth Cycles and FX (31 Jan. 1985 to 30 Apr. 2018)
-2.0% 90
-2.5% -3.0% 1985
80 1990
1995 2000 2005 2010 US vs. Rest of the World Growth Differential (LHS)
2015
USD Real Effective Exchange Rate (REER) (RHS) Sources: Bank of International Settlements (BIS), Macrobond, Record.
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Trump Dashed Markets’ Hopes
90
Citi FX Positioning Alert Indicator (PAIN) Index: USD positioning (29 Dec. 2015 to 29 Dec. 2017) Trump's Inauguration
80 70
Index Level
60
50 40
Election of Donald Trump
30 20 10 0 -10
-20 Oct 16
Dec 16
Feb 17
Apr 17
Jun 17
Aug 17
Oct 17
Dec 17
Sources: Citi, Macrobond, Record
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French Election Results were a Calming Factor for Markets
3-Month Implied Volatility (% )
12
EURUSD 3 Month Implied Volatility (30 Jun. 2016 to 29 Dec. 2018)
11
10
9
8
7
6 Dec 16
French Presidential Election, 1st and 2nd round
Feb 17
Apr 17
Jun 17
Aug 17
Oct 17
Sources: Bloomberg, Record.
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U.S. dollar has Tended to Weaken in Past Hiking Cycles USD Index during hiking cycles 3
8%
6%
USD Index, DXY (RHS)
2
4% 1
2% 0 0% -1 -2%
-2
Change since hiking cycle start (%)
Change since hiking cycle start (% pt)
Fed Funds
-4%
-3
-6% 0
60
120
180
240
300
360
420
480
Days since hiking cycle start
Sources: Bloomberg, Record. Average of past five hiking cycles (1986 to 88, 1988 to 90, 1994 to 96, 1999 to 2001, 2004 to 06).
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Inflation Expectations Matter
Interest Rate & Inflation Expectations
5
Interest Rate and Inflation Expectations (31 Mar. 2014 to 2 May 2018)
4
12m OIS
3
1 Year Inflation Breakeven
2
1 0 -1 -2 -3 Jan 14 May 14 Sep 14 Jan 15 May 15 Sep 15 Jan 16 May 16 Sep 16 Jan 17 May 17 Sep 17 Jan 18 May 18
Sources: Bloomberg, Record.
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The U.S. Leads the Developed Market Business Cycle Output Gap (% of potential output) from 31 Mar. 1983 to 31 Dec. 2017 3 2 1
Output Gap
0 -1 -2 -3 -4 -5 -6
Output gap (US)
Output gap (UK, Eurozone, Japan)
-7 -8 1983
1988
1993
1998
2003
2008
2013
Source: Macrobond, Holston-Laubach-Williams, Bank of Japan, Record.
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