Two Sigma Survey Identifies Biggest Macro Threats

April 28, 2017   Stephen Taub


Sell-side macro pros surveyed by the quant firm predict how various markets will react to eight different possible risks, including geopolitical instability and a hard landing in China.

   
   Illustration by Kimberly Lum for Institutional Investor’s Alpha.

It is hardly a secret by now that macro managers have been having a rough time for the past few years, mostly posting losses or small gains.

They generally blame the lack of volatility in the markets and abrupt changes in the direction of profitable trades, among other factors, for their woes. Some funds failed to have a large exposure to winning trades.

However, they may soon get their wish for more volatility — and other conditions they deem favorable for their strategy — if the predictions from a recent survey conducted by quantitative hedge fund titan Two Sigma Investments prove correct. The semiannual survey of about 100 sell-side macro specialists found that the potential for a trade war between the United States and a major trading partner is their chief macro concern. The respondents also expect this macro event to touch off a flight to quality, with rising bond prices and U.S. dollars but also a drop in global equities and commodities. The survey participants also see increased odds of a euro zone breakup due to upcoming European elections.

On the other hand, the macro mavens have sharply reduced their fear of a breakdown in central bank authority since the last survey, six months ago. Altogether, Two Sigma asked the respondents about eight selected macro risks and their market impact.

Two Sigma, founded by former D.E. Shaw colleagues David Siegel and John Overdeck, likes to call itself a technology company. The data-driven firm invests by using computers to make portfolio decisions. A spokesperson for the firm stresses that Two Sigma does not use the insights from the survey to turn them into models and trade on them.

Still, it is very interesting to see how the sell-side macro experts view the world. These people work in sales, trading, and research roles at broker-dealers and research firms. The most recent survey took place from March 27 through April 5.

Specifically, almost 60 percent of the macro analysts who participated in the survey fear the U.S. will precipitate a trade war with a major trading partner. The consensus is this would boost bond prices by a mere 3 percent and the U.S. dollar by 4 percent, "possibly in the flight to quality," the report notes.

At the same time, the macro analysts expect equities to take a big hit, led by an 18 percent drop in emerging-markets equities. They also fear a 14 percent drop in developed-markets equities but just a 9 percent decline in U.S. equities.

Macro mavens also see energy commodities dropping by 10 percent from a trade war.

More than half of the respondents also expressed fear a populist party will prevail in upcoming elections in Germany, France, Italy, or Norway, which they believe will destabilize the euro zone. This is significant given that in Two Sigma’s previous survey, conducted in October, there was little concern voiced for the euro zone. However, keep in mind that since the survey was conducted, populists lost in Italy and seemingly are on their way to losing in France, (although we have seen surprises in this area before).

In any case, the macro experts think populist victories could result in losses in the mid- to upper teens for developed-markets equities and emerging-markets equities.

Macro investors are concerned about how various equities markets would respond to other macro events as well.

For example, they expect declines ranging 19 percent to 23 percent for all three classes of equities — U.S., developed excluding U.S., and emerging markets — in response to an asset class or industry bubble burst.

Other potential events that the analysts say could have a big negative impact on certain equities markets include a hard landing in China or an emerging-markets sovereign debt crisis.

Looking at the euro, macro experts think the currency is most vulnerable to three events: an emerging-markets sovereign debt crisis, the upcoming European elections, and global deflation. Each of these events could cause the euro to drop 20 percent or more, these respondents assert.

On the other hand, macro sell-side experts are least concerned about global inflation. "Despite increasing reports of rising global prices and potentially expansionary U.S. fiscal policy, survey respondents do not seem to view global inflationary pressure as a chief concern," the report states. However, should this occur, the experts think the Japanese yen would be highly vulnerable.

With regard to various commodities and interest rates, energy commodities are by far most vulnerable to a variety of possible macro events, the most concerning of which is a hard landing in China, followed by a sovereign debt crisis.

U.S. bonds would fall by about 24 percent if there were global inflation, the analysts predict, while German Bunds would drop about 15 percent.

Two Sigma makes it clear it is not predicting any of these scenarios or market reactions. In fact, I am told they think they need at least five years of data to determine whether these so-called experts are making correct predictions.

In any case, if one or a few of these scenarios play out, one thing is for sure: We will finally find out whether the macro funds that have been posting mediocre returns in recent years were just making excuses or were right.



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