Dual momentum makes use of two things. The first is relative strength momentum where you compare the performance of one asset to other assets and the other is absolute momentum where you look at the asset performance with respect to itself over time. Dual momentum combines both these together. An example would be if we are deciding whether to be in stocks or not. We might look at the US stock market and see if it has been going up or down over the past year. If it has been going up, we say that absolute momentum or times series momentum is positive and we want to be in stocks because momentum means persistence in performance.
Once we know we want to be in stocks, then we have to decide which ones and there we compare the US stock market to other markets and the way I apply it to an aggregate of the rest of the world. I use the MSCI or country world index XUS and whichever of those two has been stronger over the past year, is the one that I invest in. You can apply dual momentum in many ways to alternative investments and other markets as well.
How are you applying it to the current scenario? For example, with the current trend in the US equities, what would be the strategy that you recommend?
Right now, everything is looking good. Late last year, there were some uncertainties given the economic scenario with respect to trade policies and possible leading economic indicators that were weakening. The Federal Reserve had appeared to be on the path of tightening, but now everything is on positive direction once again. All of the trends are positive and we are fully invested.
Please share with us themes that you are applying the momentum theory to and where is it that you have seen it show success?
It usually applies to portfolios of individual stocks and there are a number of exchange-rated funds and mutual funds that are set up to do that. However, that is not the best way to use momentum. Research has shown that momentum works best when it is applied to geographically diversified stock indices that gets rid of a lot of the noise, the idiosyncratic volatility and so forth and allows the pure trends to be identified and exploited better.
Some people will apply it to sectors of different markets, some to style variations. I find it works just to apply it to broad market indices themselves. Like I say, I apply it to the US market and the rest of the world to keep it very simple.
When we were talking about the global scenario, do you foresee any rotation from DMs towards EMs? Where do you see leadership emerge from?
DMs have been pretty strong and that has to do with market strength because they are more volatile. When you have strong performing markets, you would expect EMs to outperform developed markets but there are also growth factors.
The Sensex has been particularly strong. It has made new highs this month just like the US market has and you have to look at what is going on throughout the world as well to gain some sense of that. I include both, I use all countries when I am outside of the US. I will include both DMs and EMs because EMs by themselves can be very volatile. I would like to have both together.
Within EMs, what is your view on India, given that the recent rally has been on the back of strong foreign flows? Do you expect it to sustain going forward?
India has been the fastest growing economy in the world and is projected to be the third largest economy ever. So, I can see that continuation. I do not see any reason why it could not happen. Trade policies from this country can complicate things and we are all waiting to see how that gets resolved but assuming that everything goes ahead as it looks to be going ahead, the markets are telling us that everything seems positive. I see no reason why India and other parts of the world should not continue to do well.
Recently the inverted yield curve in the US was much spoken about and in the past has led to recession in the economy as well. What are you predicting this time and what is your outlook on bonds in the current macro context?
Bonds are looking positive. The Federal Reserve late last year was giving indications of tightening and now they have gone back on their policy so the bond market has been responding well.
I actually look at a number of different sub areas, I look at US markets, non-US markets, gold, oil, foreign bonds, and US bonds. The only area that is weak right now would be non-US bonds but that is on a short-term temporary basis. Going forward, the yield curve is not inverted anymore and even if it were, you know the recession does not happen for at least seven months, sometimes two or three years. The average is about 16 months after the yield curve inversion and employment is looking better, employment numbers are good here as well as in India and GDP growth looks decent. I do not have any concerns at the present time.