The US recession probability model based on the Treasury spread is a simple straightforward forecasting tool that can be followed in real time. If the spread term negative, watch out, economic winter is coming. Nevertheless, there are only a limited number of recessions and a limited number of signals. What is as useful is watching how the probability of a recession changes during non-recession periods. Periods of growing economic stress will see an increase in recession probability. For example, periods when the probability is more than 10% or even more than 5% will be times when equity markets will be under stress. These periods may pass without a recession, but there will be an impact on financial markets. This signal may have to be confirmed with other data since it provides early warnings, but it is valuable as a simple indicator.
The current reading at close to 10% is clearly showing that the economy may be seeing more stress. Granted, short-rates are manipulated by the Fed, but this warning could suggest a need for allocations to divergence strategies.
After hundreds of discussions with hedge fund managers, I am still surprised that there is a fear of revealing investment processes under the assumption that someone will steal their ideas and intellectual capital. There are few investment styles that are truly unique and special. What is special is still strategy execution – the practical process of delivering returns. Skill is with the decision-making execution of information and strategy.
All hedge funds are not created equal as the return box chart shows for the post Financial Crisis period. There is a significant amount of dispersion across hedge fund styles. Over the period 2009-2018, the difference between the best and worst hedge fund category is almost 7 percent after we account for global equities and bonds.
The attraction to private equity and other less liquid alternatives is clear from the Guide to Alternatives by JP Morgan Asset Management. The return profile is much higher for private equity and debt funds than more liquid alternatives and global bonds; however, the dispersion in returns is multiples higher than what can be expected from other public categories.
