Making sense of the market random walk between fear and greed
The Random Walk Theory most clearly laid out by Burton Malkiel, an economics professor at Princeton University, posits that the price of securities moves randomly and that, therefore, any attempt to predict future price movement, either through fundamental or technical analysis, is futile.
SGG investment approach has been much focus on macro investing and portfolio absolute return. The identification of Macro Themes and gauging of their potential impacts along with scenarios building is at the heart of the process.
and the conditions which could impact the “random walk”
The “healthiness” of such factors can be measured. You have many sentiment indicators available to measure greed and fear. Homogeneity shows for example the relationship of leadership versus broad market etc. An iconic case was during the dot.com bubble. The over-performance of the Nasdaq 100 versus Nasdaq composite index (1998-2000) became staggering and the most impressive was the narrowing leadership within the Nasdaq 100. We all knew it was a bubble but +50% over performance in two years is a long period. Homogeneity was getting worse and a clear sign of bad time ahead but timing such factors can be frustrating.
Two main sources have inspired SGG work over the years.
Risk Parity (PB Research is an excellent reference along with other factor based portfolios models)
and Chris Cole, from Artemis Capital for his work on volatility and how to build a time proof 100 years portfolio.
SGG’s works on Volatility led to a different look over the market behavior. The randomness of market (price action) is the result of all market participants activities and above exposed factors.
What if the behavior of randomness could explain above factors and some more?
Here you have a chart showing in Google trend the interest over time of the word “Ukraine”. Such interest over time is similar to the relevance/importance of the factors among investors overtime. The diffusion of the relevance overtime is part of the drivers of randomness.
SGG developed proprietary tools
- An alternative measure of volatility based on the real market moves. Basically it measures the travelling distance of an asset/index.
- An adjusted Return Index relative to the price action and such alternative measure
The observations are interesting!
The random walk /price behavior can be split into three components.
- Trend in Price
- Trend in Volatility
- Trend in Adjusted Return
In simple terms, the behavior of any asset or combination of assets (Portfolio for example) exhibits these three characteristics. (Green means positive, gray, neutral and red negative impacts)
The three components provide a solid risk matrix which can be used for investment decisions, market observations and opportunities spotting.
Here a hybrid 60/40 Portfolio with a 15% Gold allocation. Adjusted Return was the first to provide a negative in Mid November 2021.Then Price and Vol. etc., meaning that by early January 22, the portfolio was basically 100% cash (BILS ETF)
The top part is the price, Middle part is the alternate measure of volatility and Bottom part is the Adjusted Return as exposed before (composite shorter version)
It is similar to a tripod. When the three factors synchronize positively/negatively it usually results in solid trends.
Decades of charts review confirm such behavior. The underlying characteristics of the market random walk are very useful and can be used for risks.
If you wish to better understand, just register (its free). There is a document with more in depth details.
