PDF Download: Risk Management with ET Pro
There are plenty of “use cases”, to employ some marketing
jargon, for the financial media narrative research that we report in ET
Professional. If you’re a slow-twitch macro trader, and who isn’t these days in
one form or another, our research can identify specific macro trades with an
appropriate time frame. If you’re a value investor with a specific view on a
stock or sector, our research can identify when your view (or an opposing view)
begins to get narrative traction.
The universal use case for ET Pro research, though, is
portfolio risk management.
Whether you’re a trader or a portfolio manager or a
financial advisor or an allocator, we can help you identify both the inflection
points and the trajectory of the market Zeitgeist – particularly the question
that any long-term portfolio owner MUST get roughly right in order to succeed: are
we in an inflationary or deflationary world, and how quickly (if at all) and in
what ways is that world changing?
There’s no single trade we can recommend off this
research that will be useful for all of our subscribers … probably not even a
majority of subscribers. But every subscriber cares about the way their
individual investment exposures work with each other to create (or not) a
coherent and understandable investment whole, and we CAN help you with that.
Every ET Pro subscriber cares about the WHY of their
portfolio. If I’m down this month, why am I down? If I’m up this month, why am
I up? Are the components of my portfolio acting the way I would expect them to
act given what’s happening in the world? We can talk about this in terms of
covariance matrices and correlations and volatility skews and any number of
ten-dollar words if you like, but those words are all getting at one simple
question: do I understand why my portfolio is doing what it is doing?
Understanding the WHY of your portfolio is the
fundamental purpose and meaning of risk management.
Unfortunately, all of our risk management heuristics –
another ten-dollar word that means our “rules of thumb” or our basic sense of
the WHY of portfolio construction – have been developed in a deflationary
Zeitgeist. We’ve had 40 years of declining interest rates, and more recently
we’ve had a solid decade of central banks doing anything and everything –
literally, “whatever it takes” – to support financial assets against
deflationary outcomes. We are all well and truly trained in deflationary risk
management of portfolios, regardless of what type of portfolio we work with,
and we are all well and truly defended by central bankers against deflationary
That’s why I think the biggest practical investment risk
for everyone reading this note is a shift from a deflationary Zeitgeist to an
inflationary Zeitgeist. Sure, that shift will affect a trader’s trades
differently than it affects an investor’s investments and differently than it
affects an advisor’s advice and differently than it affects an allocator’s
But it will affect everyone – trader, investor,
advisor, and allocator alike – differently in the same way.
None of these portfolios will work the way “they’re
supposed to” in a shift from deflationary expectations to inflationary expectations.
The WHY of these portfolios – whatever that WHY might be – will no
longer make as much sense.
The solution? To start exercising a new set of risk
management muscles now, well before you need those muscles to carry a heavy
How? By learning how to “see” the shift in the Zeitgeist
and tracking the WHY of your portfolio as that shift occurs.
Here’s how ET Professional can help you see a change
in the Zeitgeist …
I’m going to call your attention to a couple of charts
that you can find in the Monitors section of the ET Pro
website. When you click on any of the five Monitors for a given month – Inflation,
Central Bank Omnipotence, Trade & Tariffs, US Fiscal Policy, and Credit
Cycle – you’ll arrive at a page that gives a quick summary of our research on
that specific narrative topic for that specific month. What you’ll also see at
the top of each page is a link to a Powerpoint deck, a PDF
version of that same
deck, and the underlying
data for the deck in Excel. Those decks and that Excel file contain all
historical data and charts for all five Monitors. In other words,
you don’t have to make five separate downloads for five separate Monitors to
get the most recent data and charts … one will do.
In this note on a Zeitgeist shift from deflation to
inflation, I’m going to focus on two narrative Monitors – Inflation and Trade
& Tariffs. Inflation is an obvious choice, because its narrative
context in any queries we set up is a direct match for what we’re trying to
measure. If narrative Missionaries want to talk about inflationary impulses and
expectations, they use the word “inflation” a lot. With deflationary impulses
and expectations, though, it’s a little different. People use many different
phrases to mean deflation, but they rarely use the word itself. So when people
talk about “slowing global growth”, they mean deflation. When people talk about
“credit freeze” or “banking crisis”, they mean deflation. When people talk
about “trade war” or “tariffs”, they mean deflation. For the past year or
so, ever since the Trump White House launched this as its primary foreign
policy initiative, financial media about Trade & Tariffs has been the
dominant narrative context for HOW people talk about deflation.
For both Inflation and Trade & Tariffs, I’m going to
focus on the patterns we’ve observed in Narrative Attention. To recap
(and you can read more on this in The Epsilon Strategy
note from the other week), Narrative Attention measures the persistence and
prevalence of a given financial narrative topic within the larger universe of
ALL financial narrative topics over time. It’s a measure of how central the
Inflation-relevant articles or Trade & Tariff-relevant articles are to ALL
financial media articles over time. We think it’s a good measure of how much
“drum-beating” the financial media and Wall Street are doing on a given topic,
and we calibrate its measurement by how much more or less active the given
month’s drum-beating is relative to the average level of drum-beating for that
So in February, March and April of 2018, the level of
financial media and Wall Street effort to call attention to inflation spiked
well above average. That effort largely collapsed in May 2018, climbed back to
“average” in the fall, saw another spike in December, and then has fallen again
sharply so far in 2019.
In contrast, here’s the Narrative Attention timeline for
Trade & Tariffs over the same timespan.
For all practical purposes, there was no Trade &
Tariffs narrative before March 2018, but once it was introduced by the Trump
Administration it became an enormously powerful narrative from a media
drum-beating perspective. By August the Trade & Tariffs Attention score is
much higher than the Inflation Attention score was at its peak, and stayed that
way through December. In January of this year, however, Trade & Tariffs
Attention started a sharp decline, and March took us back to levels not seen
since the narrative was launched.
For both Inflation and Trade & Tariffs, these
measurements ring true for our subjective experience with these narratives.
The spike in the Inflation drum-beating was very noticeable to us last spring,
and we wrote about it then, as was the incessant Trade War! narrative
and meme of last fall.
So now let’s put these Attention charts together in one
graph, and let’s include the Central Bank Omnipotence Attention data for good
I’d draw two conclusions from this chart:
- December was an INSANE month for narrative drum-beating and Attention scores. All three of these core macro narratives show above-average media Attention effort, and I don’t think it’s an accident that December was an insanely bad month for global risk assets, culminating in a shocking (to me, anyway) about-face in Fed policy and guidance at the very end of the month. I don’t think that was a coincidence. I think that the end-of-month reversal in Fed policy was the intended and successfully executed result of all of that end-of-world Wall Street drum-beating.
- In general, though, and to quote the Highlander catch phrase, there can be only one! One dominant narrative that draws the lion’s share of market attention, that is. Last spring a strong narrative emerged that inflation was starting to bite. That narrative collapsed as a deflationary narrative of a global trade slowdown emerged out of nowhere, taking center stage and dominating financial media (and crushing risk assets), until that narrative was in turn vanquished by a resurgent Fed Omnipotence story. Notably, both the deflationary Trade & Tariffs narrative AND the Inflation narrative have diminished as the Fed Omnipotence narrative has surged.
So what’s next? This, too, shall pass. Meaning that the
Fed Omnipotence narrative will lose its dominant position in a couple of
months, to be replaced by … drumroll, please … either a resurgent and
deflationary Trade & Tariffs narrative OR a deflationary Euro Crisis
narrative OR a resurgent Inflation narrative.
This is the narrative playbook I laid out in Things Fall Apart, Part 3.
It’s all happening.
I think there are 3 deflationary narratives in the world
today – a Fed-tightening recession, a China-trade recession, and an Italy-euro
crisis/recession – what I called the Three Horsemen of the Investment
Semi-Apocalypse in that note.
Of the three, the Fed-tightening recession is now off
the table. We’re done with that one, and Trump won’t allow it to return.
One deflationary Horseman down, two to go.
Could we have a resurgence of the deflationary China
Trade War narrative? Could it evolve into some sort of deflationary Europe
Trade/Currency narrative. Absolutely. But even if these narratives spike for a
couple of months, they will ultimately be defeated by the Central Bank
Omnipotence narrative, just as they were in December.
Inflation, on the other hand, what I call the Fourth Horseman
of the Investment (True) Apocalypse … there’s no taking that off the table.
There’s no Omnipotence narrative that’s geared to deal with THAT, because all
the central bankers have told us that they’re not going to deal with THAT, that
they’re more than happy to let inflation ride back into town. And so it will.
Just like it did last spring, only this time it will stay for a while longer.
Sure, it will eventually get beaten back for a bit by a deflationary story, but
each time it will come back stronger than before.
That’s how a Zeitgeist shifts. Not in one fell swoop, but
in an ebb and flow. Just more flow than ebb. All taking place most clearly in
Until one day you’re swimming in an entirely new ocean
ET Professional is here to help you see that ebb and
flow in narrative-world and help you prepare for it.
Because whether you’re a trader or an investor or an advisor or an allocator, we all have one shared directive: Don’t Drown!
PDF Download: Risk Management with ET Pro