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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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WisdomTree Market Update  

Chris Gannatti at the Central Banking Series with Banque de France in Paris, France on May 14, 2018.

WisdomTree Market Update  

Chris Gannatti at the Central Banking Series with Banque de France in Paris, France on May 14, 2018.