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View All Insights ↗Risks, whether global coming from a global crisis, such as the Covid pandemic and high inflation, or local, such as a controversial presidential election, can be reflected in the level of Credit Default Swaps (CDS) on government debt. The CDS reflects the perception of sovereign default risk but also can reflect economic and geopolitical risks which can in turn affect equity markets. The Covid pandemic, high inflation, a global slowdown, the war in Ukraine, build-up of global debt, and the recent rise in oil prices are some of the recent global risks. In March 2023, during the lead up to the U.S. debt ceiling crisis, we gave an analysis of 5-year CDS spreads around the world. Looking at the CDS markets currently, what are they telling us about risks of the global markets?
Most noticeably, U.S.CDS started to rise in April 2022 connected to the debt ceiling crisis and the banking sector stress and reached a local peak in March 2023. It is currently rising again with the possible government shutdown.
Italian CDS tends to be an outlier. It rose dramatically during the early days of the Covid crisis in 2020 and rose again in July 2022 with the resignation of Prime Minister Draghi and the subsequent September 2022 election of Meloni. German and French CDS tend to be low and steady, rising modestly during the early days of the Covid.
U.K. CDS rose dramatically in September 2022 connected to Liz Truss’s budget proposal. U.K. CDS has subsequently declined but stabilized.
Japanese CDS are low and steady, rising modestly during the early days of the Covid pandemic. Indian CDS tend to be higher than those in China, Korea, and Japan. They spiked during the early days of the Covid pandemic. Chinese, Indian, and Korean CDS spreads started to rise again in the Spring of 2022 with first the possible default on U.S. debt and stayed elevated in the Fall of 2022 with rising global interest rates and risk of a U.S. recession. Subsequently they have declined.
In general, Latin American CDS spreads tend to be higher than for Asian emerging markets. Over the period looked at, Brazil’s CDS spreads tend to be higher than most other markets causing our scaling for CDS to be increased on this graph. All three Latin American CDS rose during the early part of the Covid pandemic and also, like Asian CDS, rose during the Spring/Fall of 2022 with the possible default on U.S. debt, rising global interest rates, and risk of a U.S. recession. Like Asian CDS, spreads have declined since the Fall of 2022.
Turkish CDS is perennial outlier causing the scaling of the graph to be increased even beyond Latin America. Turkish CDS rose during the Covid crisis in 2020 and again considerably in the Spring 2022 with the Russian invasion of Ukraine. They rose again during the Turkish Presidential election in Spring 2023 but have fallen since then. Hungarian and Polish CDS rose in the Fall of 2022 most likely with the increase in inflation and proximity to the war in Ukraine. Czech Republic CDS have been narrow and steady.
Conclusion
Globally CDS spreads are currently tending to narrow, except for a modest increase in two important markets - U.S. and China. The modest widening for the U.S. is possibly explained by the looming government shutdown. For China, it can perhaps be explained by the Chinese economic slowdown and real estate crisis. We are hoping that the risks in both these markets can be contained.
Disclosure: This publication is provided by Heckman Global Advisors (“HGA”), which is not an independent entity but is a Division of DCM Advisors, LLC, a registered investment adviser. The region and sector allocations recommended herein are solely those of HGA and may differ from those of other business units of DCM Advisors, LLC. Nothing contained herein constitutes an offer to sell or a solicitation of an offer to buy any security or any interest in DCM Advisors, LLC vehicle(s). The information contained herein has been obtained from sources believed to be reliable but is not necessarily complete and its accuracy cannot be guaranteed. The comments contained herein are opinions and may not represent the opinions of DCM Advisors, LLC and are subject to change without notice. All investments are subject to the risk of loss, including the potential for significant loss, and it should not be assumed that any models or opinions incorporated herein will be profitable or will equal past performance. Copyright © 2023 DCM Advisors, LLC. All Rights Reserved. These materials are the exclusive property of DCM Advisors, LLC. Unless otherwise expressly permitted by DCM Advisors, LLC in writing, please do not distribute, reproduce or use these materials for any purpose other than internal business purposes solely in connection with the management of investment funds or investment products that are sponsored or advised by you. This publication is not considered a Research report under FINRA Rule 2241(a)(11) and related rules. DCM-23-77
It seems that with the rise of social media and business news channels one would hypothesize that the time period for measuring momentum as a factor in allocating equity markets has gotten shorter. This analysis looks to see if using 3-month momentum would have added value to country allocation – especially over the most recent years.
The Heckman Global Equity Allocation Model uses a smart beta (factor based) approach to allocating the markets. Currently, in the Heckman Country Allocation Model, we use 13 investment indicators which fall into the categories of valuation, growth, risk, monetary policy, and momentum. Under momentum, we currently use momentum measured over the last 12 months for each market. This analysis tests whether shorter term momentum (3 months) would have added value as a factor for country allocation. In other words, if one overweights markets with higher 3-month momentum and underweights markets with lower 3-month momentum, would this strategy have outperformed the relevant MSCI index return.
In the Heckman Global Equity Allocation Model, we calculate a score for every market each month based on the indicators. Using momentum as an example, we start with MSCI benchmark country capitalization weights, and we rebalance the portfolio by assigning overweights to markets with higher-than-average momentum and underweights to markets with lower-than-average momentum. Each country gets an overweight or underweight allocation relative to the benchmark that is roughly in proportion to the difference between its score and the cross-market average score (with restrictions on the maximum allocation possible to small markets to avoid unrealistically large exposures). The portfolio is updated each month and performance returns (gross of transactions costs) are calculated monthly. Returns from the strategy can then be measured relative to the relevant MSCI benchmark returns.
In this analysis, we constructed the 3-month momentum factor in two ways: in local currency terms and in $US terms. There were two country universes tested: MSCI All-Country World universe (developed and emerging) and MSCI Emerging Market universe. We divided the alpha into 10-year periods since January 1989 and with the most period being January 2019 through July 2023 – obviously less than 10 years.
For the MSCI ACWI universe, as can be seen from the Charts 1 and 2, a positive alpha was produced for the first two ten-year periods from January 1989 through December 1998 and January 1999 through December 2008. However, for January 2009 through December 2018 and the most recent period of January 2019 through July 2023, this factor for country allocation would have produced negative alpha relative to the MSCI ACWI Index return.
Chart 1
Chart 2
For the MSCI Emerging Universe, as can be seen from the Charts 3 and 4, the 3-month momentum factor measured in local currency would have outperformed from January 1989 through December 2008. This is not the case of the $U.S. 3-month momentum factor since it underperformed during the January 1989 through December 1998. In addition, since January 2009, there is no clear pattern for outperformance over the MSCI Emerging Market Index either when the 3-month momentum is measured in local currency or in $U.S.
Chart 3
Chart 4
What is the relationship of market consensus earnings growth forecasts for a market (aggregated bottom-up from company data)¹ and future country returns?
To answer this question, for each of the MSCI Developed and Emerging markets, each month, we looked both at the consensus forecasted earnings growth for the current year (after all one does not know the actual earnings growth for the current year until early the following year) as well as the consensus forecasted earnings growth for the following year. We correlated both the earnings growth forecast for the current year and the earnings growth forecast for the following year with each market’s MSCI returns over 3 periods:
- Over the next 3 months
- Over the next 6 months
- Over the next 12 months
We cover 23 developed and 24 emerging markets as defined by MSCI. The study utilizes a database and returns covering a 30-plus year period from January 1990 through March 2023 for most developed markets and from August 1992 through March 2023 for many emerging markets. The charts below show the average correlation for developed, emerging, and all markets of forecasted earnings growth with market returns over 3 different periods of time.
These results suggest that at the market level there is little correlation in the near term (3,6, and 12 months out) with earnings growth forecasts and stock prices at the market level.
Follow Heckman Global on LinkedIn for more Insights.
¹ I/B/E/S, Heckman Global Advisors, Bloomberg
Disclosure: This publication is provided by Heckman Global Advisors (“HGA”), which is not an independent entity but is a Division of DCM Advisors, LLC, a registered investment adviser. The region and sector allocations recommended herein are solely those of HGA and may differ from those of other business units of DCM Advisors, LLC. Nothing contained herein constitutes an offer to sell or a solicitation of an offer to buy any security or any interest in DCM Advisors, LLC vehicle(s). The information contained herein has been obtained from sources believed to be reliable but is not necessarily complete and its accuracy cannot be guaranteed. The comments contained herein are opinions and may not represent the opinions of DCM Advisors, LLC and are subject to change without notice. All investments are subject to the risk of loss, including the potential for significant loss, and it should not be assumed that any models or opinions incorporated herein will be profitable or will equal past performance. Copyright © 2023 DCM Advisors, LLC. All Rights Reserved. These materials are the exclusive property of DCM Advisors, LLC. Unless otherwise expressly permitted by DCM Advisors, LLC in writing, please do not distribute, reproduce or use these materials for any purpose other than internal business purposes solely in connection with the management of investment funds or investment products that are sponsored or advised by you. This publication is not considered a Research report under FINRA Rule 2241(a)(11) and related rules. DCM-23-47
Risks, whether global coming from a global crisis, such as the Covid pandemic and high inflation, or local, such as a controversial presidential election, can be reflected in the level of Credit Default Swaps (CDS) on government debt. The CDS reflects the perception of sovereign default risk but also can reflect economic and geopolitical risks which can in turn affect equity markets. The Covid pandemic, high inflation, a global slowdown, the war in Ukraine, build-up of global debt, and the recent rise in oil prices are some of the recent global risks. In March 2023, during the lead up to the U.S. debt ceiling crisis, we gave an analysis of 5-year CDS spreads around the world. Looking at the CDS markets currently, what are they telling us about risks of the global markets?
Most noticeably, U.S.CDS started to rise in April 2022 connected to the debt ceiling crisis and the banking sector stress and reached a local peak in March 2023. It is currently rising again with the possible government shutdown.
Italian CDS tends to be an outlier. It rose dramatically during the early days of the Covid crisis in 2020 and rose again in July 2022 with the resignation of Prime Minister Draghi and the subsequent September 2022 election of Meloni. German and French CDS tend to be low and steady, rising modestly during the early days of the Covid.
U.K. CDS rose dramatically in September 2022 connected to Liz Truss’s budget proposal. U.K. CDS has subsequently declined but stabilized.
Japanese CDS are low and steady, rising modestly during the early days of the Covid pandemic. Indian CDS tend to be higher than those in China, Korea, and Japan. They spiked during the early days of the Covid pandemic. Chinese, Indian, and Korean CDS spreads started to rise again in the Spring of 2022 with first the possible default on U.S. debt and stayed elevated in the Fall of 2022 with rising global interest rates and risk of a U.S. recession. Subsequently they have declined.
In general, Latin American CDS spreads tend to be higher than for Asian emerging markets. Over the period looked at, Brazil’s CDS spreads tend to be higher than most other markets causing our scaling for CDS to be increased on this graph. All three Latin American CDS rose during the early part of the Covid pandemic and also, like Asian CDS, rose during the Spring/Fall of 2022 with the possible default on U.S. debt, rising global interest rates, and risk of a U.S. recession. Like Asian CDS, spreads have declined since the Fall of 2022.
Turkish CDS is perennial outlier causing the scaling of the graph to be increased even beyond Latin America. Turkish CDS rose during the Covid crisis in 2020 and again considerably in the Spring 2022 with the Russian invasion of Ukraine. They rose again during the Turkish Presidential election in Spring 2023 but have fallen since then. Hungarian and Polish CDS rose in the Fall of 2022 most likely with the increase in inflation and proximity to the war in Ukraine. Czech Republic CDS have been narrow and steady.
Conclusion
Globally CDS spreads are currently tending to narrow, except for a modest increase in two important markets - U.S. and China. The modest widening for the U.S. is possibly explained by the looming government shutdown. For China, it can perhaps be explained by the Chinese economic slowdown and real estate crisis. We are hoping that the risks in both these markets can be contained.
Disclosure: This publication is provided by Heckman Global Advisors (“HGA”), which is not an independent entity but is a Division of DCM Advisors, LLC, a registered investment adviser. The region and sector allocations recommended herein are solely those of HGA and may differ from those of other business units of DCM Advisors, LLC. Nothing contained herein constitutes an offer to sell or a solicitation of an offer to buy any security or any interest in DCM Advisors, LLC vehicle(s). The information contained herein has been obtained from sources believed to be reliable but is not necessarily complete and its accuracy cannot be guaranteed. The comments contained herein are opinions and may not represent the opinions of DCM Advisors, LLC and are subject to change without notice. All investments are subject to the risk of loss, including the potential for significant loss, and it should not be assumed that any models or opinions incorporated herein will be profitable or will equal past performance. Copyright © 2023 DCM Advisors, LLC. All Rights Reserved. These materials are the exclusive property of DCM Advisors, LLC. Unless otherwise expressly permitted by DCM Advisors, LLC in writing, please do not distribute, reproduce or use these materials for any purpose other than internal business purposes solely in connection with the management of investment funds or investment products that are sponsored or advised by you. This publication is not considered a Research report under FINRA Rule 2241(a)(11) and related rules. DCM-23-77
It seems that with the rise of social media and business news channels one would hypothesize that the time period for measuring momentum as a factor in allocating equity markets has gotten shorter. This analysis looks to see if using 3-month momentum would have added value to country allocation – especially over the most recent years.
The Heckman Global Equity Allocation Model uses a smart beta (factor based) approach to allocating the markets. Currently, in the Heckman Country Allocation Model, we use 13 investment indicators which fall into the categories of valuation, growth, risk, monetary policy, and momentum. Under momentum, we currently use momentum measured over the last 12 months for each market. This analysis tests whether shorter term momentum (3 months) would have added value as a factor for country allocation. In other words, if one overweights markets with higher 3-month momentum and underweights markets with lower 3-month momentum, would this strategy have outperformed the relevant MSCI index return.
In the Heckman Global Equity Allocation Model, we calculate a score for every market each month based on the indicators. Using momentum as an example, we start with MSCI benchmark country capitalization weights, and we rebalance the portfolio by assigning overweights to markets with higher-than-average momentum and underweights to markets with lower-than-average momentum. Each country gets an overweight or underweight allocation relative to the benchmark that is roughly in proportion to the difference between its score and the cross-market average score (with restrictions on the maximum allocation possible to small markets to avoid unrealistically large exposures). The portfolio is updated each month and performance returns (gross of transactions costs) are calculated monthly. Returns from the strategy can then be measured relative to the relevant MSCI benchmark returns.
In this analysis, we constructed the 3-month momentum factor in two ways: in local currency terms and in $US terms. There were two country universes tested: MSCI All-Country World universe (developed and emerging) and MSCI Emerging Market universe. We divided the alpha into 10-year periods since January 1989 and with the most period being January 2019 through July 2023 – obviously less than 10 years.
For the MSCI ACWI universe, as can be seen from the Charts 1 and 2, a positive alpha was produced for the first two ten-year periods from January 1989 through December 1998 and January 1999 through December 2008. However, for January 2009 through December 2018 and the most recent period of January 2019 through July 2023, this factor for country allocation would have produced negative alpha relative to the MSCI ACWI Index return.
Chart 1
Chart 2
For the MSCI Emerging Universe, as can be seen from the Charts 3 and 4, the 3-month momentum factor measured in local currency would have outperformed from January 1989 through December 2008. This is not the case of the $U.S. 3-month momentum factor since it underperformed during the January 1989 through December 1998. In addition, since January 2009, there is no clear pattern for outperformance over the MSCI Emerging Market Index either when the 3-month momentum is measured in local currency or in $U.S.
Chart 3
Chart 4
What is the relationship of market consensus earnings growth forecasts for a market (aggregated bottom-up from company data)¹ and future country returns?
To answer this question, for each of the MSCI Developed and Emerging markets, each month, we looked both at the consensus forecasted earnings growth for the current year (after all one does not know the actual earnings growth for the current year until early the following year) as well as the consensus forecasted earnings growth for the following year. We correlated both the earnings growth forecast for the current year and the earnings growth forecast for the following year with each market’s MSCI returns over 3 periods:
- Over the next 3 months
- Over the next 6 months
- Over the next 12 months
We cover 23 developed and 24 emerging markets as defined by MSCI. The study utilizes a database and returns covering a 30-plus year period from January 1990 through March 2023 for most developed markets and from August 1992 through March 2023 for many emerging markets. The charts below show the average correlation for developed, emerging, and all markets of forecasted earnings growth with market returns over 3 different periods of time.
These results suggest that at the market level there is little correlation in the near term (3,6, and 12 months out) with earnings growth forecasts and stock prices at the market level.
Follow Heckman Global on LinkedIn for more Insights.
¹ I/B/E/S, Heckman Global Advisors, Bloomberg
Disclosure: This publication is provided by Heckman Global Advisors (“HGA”), which is not an independent entity but is a Division of DCM Advisors, LLC, a registered investment adviser. The region and sector allocations recommended herein are solely those of HGA and may differ from those of other business units of DCM Advisors, LLC. Nothing contained herein constitutes an offer to sell or a solicitation of an offer to buy any security or any interest in DCM Advisors, LLC vehicle(s). The information contained herein has been obtained from sources believed to be reliable but is not necessarily complete and its accuracy cannot be guaranteed. The comments contained herein are opinions and may not represent the opinions of DCM Advisors, LLC and are subject to change without notice. All investments are subject to the risk of loss, including the potential for significant loss, and it should not be assumed that any models or opinions incorporated herein will be profitable or will equal past performance. Copyright © 2023 DCM Advisors, LLC. All Rights Reserved. These materials are the exclusive property of DCM Advisors, LLC. Unless otherwise expressly permitted by DCM Advisors, LLC in writing, please do not distribute, reproduce or use these materials for any purpose other than internal business purposes solely in connection with the management of investment funds or investment products that are sponsored or advised by you. This publication is not considered a Research report under FINRA Rule 2241(a)(11) and related rules. DCM-23-47