1

FINA 6222FB
SELECTED TOPICS IN FINANCE:
MACRO INVESTMENT STRATEGY
MACRO ANALYSIS TO MARKETS – 4
MACRO INVESTING WITH DATA
Dr. Paul M. Kitney
Term 3, 2021-22
 Using Data in Macro Investing
• Macro Investing Indicators – Some selected indicators used for
both investment process and risk management
• Macro Finance Data Analysis – Examples of using macro statistical
analysis to assist in an equity investment strategy
• Factor Analysis, Macro and Stock Picking in Equity Strategy – What
financial factors drive performance of equities and under what
macro conditions should and do they work?
• Introduction to ETFs and Factor Analysis in ETFs – Smart Beta –
Guest Presenter – Mr. Aleksey Mironenko (Capital Company,
Former head of APAC Fixed Income and Asia ex-Japan Institutional
Sales - Blackrock i-shares)
 3

MACRO INVESTING
INDICATORS
 (CBOE) VIX Index
• Up to the minute market estimate of the expected volatility of the
US S&P 500 Equity Index
• Calculated using the midpoint of real-time S&P 500 option bid/ask
quotes
• Prior to 1993 it was calculated as an average of implied option
volatilities
• Now, with the help of Goldman Sachs it uses a methodology,
which aggregates the put and call option prices over a wide range
of strike prices, and calculates the market’s perception of what
options’ strike prices will be hit by underlying stocks during the
remaining time to expiry.
• Bloomberg Code: VIX Index
 (CBOE) VIX Index

• This is the VIX leading up to March 2020, during the COVID-19

shock.
• Expected volatility was rising very sharply during this time.
• VIX tends to rise when equity markets fall and falls when equity
markets rise. Market volatility tends to be higher during declines in
equity prices rather than rises in equity prices
 Economic Policy Uncertainty Index
• Big data study that uses text mining to scan newspaper for key
words related to economic policy uncertainty
• There are 21 countries that have an economic policy uncertainty
index: Australia, Belgium, Brazil, Canada, Chile, China, Columbia,
Croatia, France, Germany, Greece, Hong Kong, India, Ireland, Italy,
Japan, South Korea, Mexico, Netherlands, Pakistan, Russia,
Singapore, Spain, Sweden, and UK
• There is also a Global Economic Policy Uncertainty Index, which
computes a GDP weighted average of the 21 national indices
• Each country index represents the relative frequency of three joint
terms related to 1. Economy (E), Policy (P) and Uncertainty (U)
• Source: “Measuring Economic Policy Uncertainty” by Scott Baker, Nicholas
Bloom and Steven J. Davis at www.PolicyUncertainty.com
 Economic Policy Uncertainty Index
• According to studies, including the IMF (e.g. Policy Uncertainty in
Japan, Arbatli, Davis, Ito, Miake and Saito (May 30 2017), IMF
Working Paper), increases in economic policy uncertainty tend to
lead falls in investment, employment and output (GDP).
• Evidence shows that credible policy plans and good
communication of policy plans can reduce policy uncertainty
• Studies in the UK in the lead up to Brexit argue that the large
increases in policy uncertainty leading to that event would lead to
lower projected output. "What is Brexit-related uncertainty doing
to United Kingdom growth? " (May 2016)
(www.policyuncertainty.com/research.html)
• .
 US EPUI (Feb 2020)

Source: “Measuring Economic Policy Uncertainty” by Scott Baker, Nicholas Bloom and Steven J. Davis at
www.PolicyUncertainty.com

• While the equity market had not yet corrected, the US EPU had started
to adjust upwards to COVID-19.
• In a study on the US economy, "Measuring Economic Policy Uncertainty"
(2016), (www.policyuncertainty.com/research.html) , a 90 point upward
move in the EPU index leads to a decline of 1.2% in
• industrial production and 0.6% in investment
 Global Economic Policy
Uncertainty Index (Jan 2020)

• Source: “Measuring Economic Policy Uncertainty” by Scott Baker, Nicholas Bloom and Steven J. Davis at
www.PolicyUncertainty.com.

• While COVID-19 had hit China/HK at this time, it was not yet
reflected as a global policy uncertainty event.
 Credit Market Stress Indicators – CDS
• For monitoring credit market stress the most convenient set of
indices to follow are those of credit default swaps (CDS)

• Credit default swaps act as insurance against the default of the

issuer of the underlying bonds.

• If the probability of default increases, the CDS value increases,

thus the cost of insurance against default goes up

• Corporate Credit default swap indices track a basket of issuers CDS

values, so as to look at the general risk of default of that credit
class (HY or IG)
 Credit Market Stress Indicators – CDS

• In and APAC investment strategy, we follow certain corporate and

sovereign CDS indices – Some global and some regional.

• Some selected examples to follow: North American Investment

Grade CDS, China Sovereign 5-Year CDS
• Sovereign Monitor (Bloomberg): SOVR (5 Year CDS Comparison)

• Corporate Monitor (Bloomberg): CDX

 CREDIT DEFAULT SWAP INDEX
MONITOR (CDX)

Source: Bloomberg, Note: Data as of May 2, 2021

• CDX is a monitor to track investment grade (IG) versus high yield

(HY) corporate credit default swap indices
 CREDIT DEFAULT SWAP INDEX
MONITOR (SOVR)

Source: Bloomberg, Note: Data as of May 2, 2021

• SOVR is a monitor to track global sovereign (5 year) CDS.

 North American IG CDS
(COVID-19 Shock)

Source: Bloomberg, Daiwa

Note: Data as of 13 March 2020; Weekly; We use CDX IG CDSI GEN 5Y as an indicator

• Investment grade credit shock is captured in the rise in the North

American (US and Canada) 5-Year CDS index.
• It is a measure indicating that US/North American credit spreads
are rising during the Covid-19 even in March 2020.
 China Sovereign 5-Year CDS
COVID Shock

Source: Bloomberg, Daiwa. Note: Data as of 13 March 2020; Weekly; We use

CHINAGOV CDS USD SR 5Y D14 CORP as an indicator

• China’s Sovereign Bond 5-year CDS shows a small rise in China’s

risk of default on government debt. This is much lower than the
GFC in 2007-2008 or even the capital flight episode in 2015/16.
 China – CDS vs Actual Defaults

Source: Wind, Daiwa, Note: data as of 10 March 2020

• The rise in China’s CDS leading up to March 2020, also tracks the
increase in frequency of actual corporate defaults in China.
 Credit Market Stress Indicators – CDS
• Changes in corporate credit spreads changes in a given asset class
(HY, IG) or region (Japan, US, China, Korea, etc) can be monitored
using CDS indices
• Changes in corporate CDS obviously are important for credit
market investors but signals in the debt markets can often lead the
equity market. That is, when credit spreads may rise (fall) before
equities fall (rise).
• Astute equity analysts and portfolio managers (usually the top
hedge funds) will watch indicators on the full capital structure
(debt and equity) of firms, industries, when making stock, sector
and market equity investments.
• (Relative)Changes in Sovereign CDS are a good indictor of changes
in country risk premium, which is useful for macro-economic
analysis.
 18

MACRO FINANCE
DATA ANALYSIS
 IS INFLATION ALWAYS BAD
FOR EQUITIES?
• We know from the Gordon Growth model at that rising interest
rates and rising risk premium boosts the required rate of return,
ke, which is negative for equity prices.
• Also, when inflation and inflation expectations rise, so do nominal
interest rates, such as bond yields, via the Fisher Effect
• We will see empirical examples of inflation not being so negative
for equities on certain occasions, when there are other variables
moving at the same time.
• We will show that these empirical results are consistent with the
GGM
 MACRO & EQUITY VALUATION

Source: Bloomberg. Daiwa Capital Markets (Hong Kong Ltd). Note: Data as of February 2021, Monthly; Blue area
refers to deflation phase, light blue area refers to reflation phase and red area refers to inflation phase.

• Bond yields impact equity valuation (P/E) in a non-linear way.

• Why can there be rising bond yields and P/E’s at the same time
• in the Gordon Growth Model?
 BOND YIELD – PE RELATIONSHIP
• According to the GGM,

• In his model if interest rates (bond yields) rise, then ke rises and
the fair value, price for equities, Po falls.

• This would mean that as bond yields rise, the P/E multiple should
fall, if all other variables remain constant.

• However, all variables are not constant and it may depend on the
phases of the economic cycle we are in
 BOND YIELD – PE RELATIONSHIP
• However, what if the economy is in an economic recovery where
GDP growth, earnings growth, and ultimately dividend growth is
rising?
• It is typically during a recovery phase (from deflation to reflation
stages) – usually after a financial and economic shock – when
monetary policy is accomodating, when GDP growth recovers fast
(also due to a low base effect) so that the growth in dividends
recovers very fast
• If dividend growth recovers faster than the increase in the required
rate of capital, then you can have rising bond yields and dividend
yields
• What leads to the change in this relationship in the pink section of
the chart?
 JAPAN INFLATION & FX/Equity
Market Correlation
• Any foreign investor who has invested in Japanese equities over
the past 30 years knows there is common theme to Japanese
equity market performance
• Japanese equities tend to outperform peers (in local currency)
when the USD is strong (JPY is weak). Why?
• The problem is that in foreign currency, you might make money on
JPY returns but you lose at least part of it in USD terms, via FX.
• Hence the correlation of Japanese equity market returns to JPY is
important. The lower the correlation the better, because it means
that other factors, aside form FX is driving earnings, and ultimately
equity market performance.
 JPY/TOPIX correlation and Inflation

Source: Bloomberg, FactSet, Daiwa Note: Data as of 10 March 2020

• As inflation rises (falls) the correlation between TOPIX and JPY

falls (rises). With higher inflation TOPIX returns are less dependent
on a weak FX
• Why? Large cash holdings on Japanese balance sheets. As inflation
Increases, the opportunity cost of holding cash rises, encouraging
firms to pay higher dividends (boosting valuation via GGM),
increase share buy backs (reducing equity supply) or increase
capital spending boosting future growth of dividends.
 ASIAN EQUITIES & INFLATION
CORRELATION

Source: MSCI, Daiwa Custom Products Group, Data: July 2018

Note: Vertical axis shows the number of equities within MSCI Asia ex-Japan that fall within each histogram bucket, listed on the horizontal axis

• Most Asian equities like a little inflation

• Rising inflation expectations favor consumer discretionary group
• Steepening yield curves boost bank sector earnings
• Insurance companies benefit from rising bond yields as higher
yielding securities assets help fund their long-term liabilities
 Inflation Sensitive – Asia ex-Japan

Source: Daiwa, Bloomberg.

Note: Data as of 11 July 2018. We select the stocks with 2-year inflation beta in top quintile and a Buy (1) rating. Shaded stocks are our top picks
 JPY/TOPIX correlation and Inflation
Yield curve slope and change in yield curve Financial sector earnings revisions

Source: Bloomberg, Daiwa. Note: Data period from 1 January 2017 to 15 May 2018 Source: MSCI, Daiwa, Factset. Note: Data as of 6 June 2018

• What can we say about China’s monetary policy in June 2018?

• Positive yield curve slope in most markets and rising in India,
Korea, Europe and Indonesia
• Positive YC slope positive for earnings and esp. for those yield
curves that are steepening? Which banks would you choose?
 28

FACTOR ANALYSIS,
MACRO & STOCK
PICKING
 What Are Factors and how are they
used in an equity investment process?
• This is a brief, non-technical introduction to Factor Investing.
• Factors are persistent drivers of equity returns. They can include
valuation ratios (P/E, P/B, EV/EBITDA) or other characteristics of a
firm such as balance sheet or cashflow factors (using defined under
the heading of “Quality” factors), or price performance (eg.
Momentum) or growth related factors such as earnings growth,
operating profit growth etc.
• Factors are often grouped into styles as mentioned above –
growth, quality, value, volatility, momentum etc.
• Many investment managers in active equity strategies identify
with certain “styles” such as value or growth investors.
• Does value always work?
Factors and the Economic Cycle

Source: Daiwa Research, OSAM

 Macro Overlays in Factor Analysis
• During periods of rising interest rates value stocks tend to
outperform growth stocks. More on this later.
• When interest rates fall high dividend yield stocks perform well as
the excess return (dividend yield – bond yield) on equity income (vs
fixed income) is in favor of yield stocks.
• Growth stocks tend to perform better than value stocks during
economic downturns and falling interest rates, as typically growth
is scarce during these times and attract a scarcity premium.
• Dividend yield stocks tend to do poorly during an economic
recovery since rising interest rates in that recovery undermine the
dividend-bond yield cap
• Quality tends to perform well in long recoveries (balance sheet,
returns, cash flow)
 Sample of Factor Performance

• Sharpe = (Annualized return – Risk Free rate)/ (Annualized Risk

Annualized risk measured by standard deviation of returns
Factor Style Definitions (Examples)

Source: Daiwa
Factor Style Definitions (Examples)

Source: Daiwa
 Defining Factors

• We will not go through the quantitative process that extracts the

factor returns (see references at the end of this section for those
interested in the technical details)
• Style factors go through a process (involving regression analysis)
based on observed characteristics of the stock
• Realization of factors constructed using accounting data, price and
other metrics from the data.
• As per the previous slides, multiple metrics used to determine the
style factors listed (using weighted average)
• Each representative factor goes through a Z-normalization process
to identify its position within the stock universe
 Steps in Using Factors in Equity
Investment Process
• Generate factor return time series for each major factor bucket:
value, quality, liquidity, momentum, yield, growth, size, low
volatility, etc.
• Identify the trends in the relative performance (excess return over
benchmark) of the factors.
• Question? Is the performance of factors acting as you would
expect given your macro overlap and macro outlook
• If yes, then conduct a screening of equities. Suppose you are
focused on Japan and in Japan value is generating the most
consistent excess returns. Then screen for the top quintile (20%)
cheapest stocks in that market
• Then these stocks can form part of your equity analysis working
list for further “bottom up” analysis.
 Macro Regime Analysis Example 1 –
Disinflation (Jan 2013-June 2016)
• In factor analysis work it is useful to do backtesting of macro
conditions you are currently forecasting for the future.
• In this example, the date is June 2019. My macro analysis was
expecting disinflation or falling inflation.
• Based on macro theory, with falling inflation, bond yields would
fall and this would be positive for high dividend yield stocks.
• I wanted an extra layer of safety by choosing quality as I believed
the “sustainability” of dividends was important. High current
dividend yield is good but if there is a weak balance sheet or low
free cash flow, I don’t want to get hit by a stock that cuts its
dividend. So, sustainable high dividend was my strategy.
• As a backtest I tested the pervious disinflation period
(Jan 2018 to June 2016) to see if the theory matches the data?
 Disinflation Regime Analysis

• Did the sustainable yield (high dividend yield plus quality)

strategy work during this disinflation regime?
Reflation Regime Analysis (July 2018)

Source: MSCI, Daiwa Custom Products, Fact Set. Note: Factor returns generated by top and bottom
quartile returns for MSCI Asia ex-Japan. Note: Data as of 10 July 2018

• In the reflationary period following the US tax cuts from early 2017
until Mid 2018, dividend growth stocks outperformed yield.
• I was advocating dividend growth stocks until disinflation
resumed.
• How do we reconcile this in the GGM?
Value Stocks and Bond Yields
Value factor excess return and US 10-year bond yield
5-day change (%) – Asia ex-Japan
25 3
20 2
15
1
10
5 0
0 -1
(5)
-2
(10)
(15) -3
(20) -4

Jul-19

Sep-19
Jan-19
Jan-19
Feb-19

Jun-19
Jun-19
Jul-19

Aug-19
Aug-19
Sep-19

Sep-19
Feb-19
Mar-19
Mar-19

May-19
Apr-19

May-19
Apr-19
Apr-19
US Bond Yield 5D Pct change (LHS) Factor excess return (RHS)

Value factor excess return and US 10-year bond yield

5-day change – Asia ex-Japan
25.0
US Bond Yield 5D Pct Change (%)

20.0
15.0
10.0
5.0
0.0
(5.0)
y = 2.4281x - 0.7236
(10.0) R² = 0.2827
(15.0)
(20.0)
-4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0
Value factor excess return (%)

Source: Daiwa, FactSet as of October 17, 2019

How should value perform in an inflation regime?

 Factor Analysis Reading List

• Fama and French (1992) – These two authors are the pioneers in
Factor analysis both in industry and academia
• Growth – Fama and French (2006), Gulen and Schill (2008)
• Quality – Piotroski (2000), Soliman (2008)
• Low Volatiity (min vol) – Ang, Chen and Xing (2006)
• Momentum – George and Hwang (2004)
• Size – Fama and French (1992), Daniel and Titman (1997)
 42

INTRO TO ETFs &

FACTORS IN ETFs –
SMART BETA
 Guest Speaker – Aleksey Mironenko

• Currently – Managing Director and Head of Global Investment

Solutions (Capital Company)
• Graduate of the Stern School of Business, New York University
• Aleksey spent many years in Blackrock’s i-Shares (ETF) business in
New York, London, Tokyo and Hong Kong
• At Blackrock, Aleksey held numerous senior positions in
Blackrock’s i-shares division, including: Head of APAC Fixed
Income, Head of Asia-ex Japan Institutional sales
• Aleksey brings a wealth of experience and knowledge of the ETF
business to our classroom at CUHK