Trend Following to Diversify
Let us take a look at some ideas related to Trend Following. Settling on zeroing in on when stocks are down more than 2.5% in any month. You can see the negative skew in stocks and positive skew in Trend Following. For the trend following data, we use the MLM (Mt. Lucas) Trend model:
The trend positions were completely different during a few time periods. For example:
October 2008 is the worst month. Trend Following gained with short commodities and long bonds.
Fast forward to the thumping in stocks so far this year...
Trend Following gained with long commodities and short bonds.
So what does investing in trends do for investors? How about for a "traditional" portfolio. Let's use an example:
Trading FX: As you may have seen, the Euro went through parity. The Japanese Yen has dropped a lot.
There’s a few reasons for the moves – but one of the drivers is the different path of monetary policy in the US vs abroad. The US is hiking rapidly, the Japanese are trying to keep their 10y bond under 0.25%. That pressures the Yen weaker.
So far so good. Now zoom out…what is impacting stock portfolios in the US?
Higher interest rates, high inflation, rising yields.
What diversified trend often manages to do is to focus right into the macro area that is impacting stocks, and hop on board, helping to cushion things.
Apply this to some other places too…the oil complex for example. Same idea – this time long something rather than short.
What trend does is seek to spread out the diversification, and allows long and short exposures. Longs in the oil complex, shorts in foreign currencies, shorts in global bonds.
Can this always benefit a portfolio? There are no guarantees, only probabilities. But there can be various benefits to increasing the probability of diversifying a portfolio by implementing trend following. At least it is something to investigate in more detail and keep in mind.