Positive 1-year forward equity returns have been the norm historically (70% of the time over the past 150 years for the S&P 500). But equity returns are eminently linked to how market participants envisage future economic growth, so any shift or rapid drift in growth expectations away from “normality” will significantly impact share price behaviours, potentially exposing a portfolio to a large sudden drawdown that is usually hard to foresee and impossible to time.
Butterwire’s iGDP indicator is derived from daily price movements of highly traded financial instruments (currencies, treasuries, commodities, credit, equities, etc), after performing a principal components analysis on the securities returns. iGDP therefore represents a real-time indicator of growth expectations as priced in by financial markets. While it is a powerful regressor of future equity returns, it does not predict future growth or returns. Rather, it provides a simple reliable number that reflects current market expectations of future growth.
iGDP is what the Butterwire engine uses to dynamically adjust how it computes base scores (specifically by adjusting the weights it places on some base score factors – for instance, “Finances Fitness” factors become more important in a downcycle), but it can also be used by investors to help decide on what market exposure to take for instance whether to move a portion of the portfolio to cash (see also section 5c). It is also how it computes a stock’s global score, which denotes how pro-cyclical or a-cyclical it is. Typically banks and commodities stocks tend to have high macro scores whereas consumer staples and big pharma stocks tend to sit at the other end of the spectrum.
Besides iGDP, two other macro factors are considered when establishing the macro profile of a stock: iEMC (Emerging Markets Capital flows) and iLCI (Late Cycle Indicator), respectively reflecting the extent that growth is fuelled by (investments in) Emerging Economies rather by (consumption in) Developed Economies, and the extent that growth is perceived as inflationary or disinflationary). Butterwire uses these 3 global macro indicators to assign a macro profile to each stock it covers, to reflect the extent that a stock is sensitive to changes in global growth expectations (we call this sensitivity the “iGDP beta” – high values mean the stock is highly pro-cyclical), to changes in growth expectations favouring EM/Investment over DM/Consumption (ie. the “iEMC beta”) and to changes in inflation expectations (ie. the “iLCI beta”). To be clear, all stocks are growth-sensitive compared to, say, cash, gold or government bonds, it’s just that some are more so than others. As such, the Butterwire engine can profile them based on their “macro beta footprint”. So, stocks that strive in a high growth, high investment, high inflation environment are labelled “Inflationary EM growth” stocks and many commodities, financials and capital goods stocks fit this profile, Conversely, stocks that perform best in a high growth but disinflationary environment are labelled “Disinflationary EM or DM growth” stocks and consist of many consumer discretionary and technology stocks. The resulting 7 profiles identified are represented in the chart below. Their performance is tracked by the engine, reported in the markets section of the app, and it is also part of the way the engine analyses the performance of your portfolio.
Lastly, these 3 macro variables are used to derive the market return (1-yr forward) that would be expected should the same conditions prevail one year from now. This expected market return is called iEMR and is the other metric represented in the first chart of this section. Note that however powerful these metrics are at capturing the present state and assumptions of world markets as well as what would happen if things kept at current levels, their predictive power is limited as a macro discontinuity can occur the next day, suddenly forcing a re-pricing of everything.