Most research firms focus on just one of the three most critical forces impacting asset prices for their research offerings. We not only analyze all three Gravities individually, but we understand how the Fundamental, Quantitative and Behavioral Gravities work together to impact asset prices over different time frames. This three-dimensional view of financial markets allows us to consistently catch macro moves before the majority of other market participants.
The Fundamental Gravity
The two most important variables driving the risk and return of asset classes are: 1. economic conditions and 2. how central banks respond to those conditions. We refer to these collective variables as the Fundamental Gravity. A given company’s or market’s Fundamental Gravity is driven by the economic conditions and central bank policy of the economy where that particular asset is domiciled.
The illustration above shows just how important it is to be aligned with the Fundamental Gravity. The chart above shows the performance of several US sectors, during the most current economic conditions. Many investors believe asset classes have inherent reward-to-risk characteristics, like Treasuries are "safer" than stocks and utility stocks are "safer" than financial or technology companies. The reality is that the risk and returns of asset classes, as well as their relationships to each other, varies depending on the prevailing economic conditions. Above you can clearly see the asset classes that many consider to be "safe" experienced lower relative performance, coupled with maximum drawdowns 3-4 times worse than the assets investors consider to more "risky." Aligning yourself with a market or company's Fundamental Gravity allows you to side step possible risks and position yourself in the asset classes that are most likely to experience higher returns and lower downside risk.
The Behavioral Gravity
The Behavioral Gravity is our gauge of how investors perceive a given market and more importantly, how that perception is changing as we move through time. By quantifying the "humanness" component of financial markets we are able to determine whether our view of a particular market is unconventional, or whether it has already become the herd’s mentality.
The chart above shows our Behavioral Gravity Index, which helps us monitor market particpants' bias of a particular market. We consider any reading above 2 to be an extreme and consensus bullish bias. We consider any reading less than -2 to be an extreme and consensus bearish bias. You can see from the chart above, which goes back a little over a year, how investors' perception of these three markets have changed as we moved through time.
The Quantitative gravity
If the Fundamental Gravity tells us how a market should be trading, the Quantitative Gravity tells us how the market is trading. We track a number of different quantitative factors such as volume, volatility and cross asset relationships, just to name a few. As with the Fundamental and Behavioral Gravity, we follow our three principles of better understanding what's happneing now, as well as focusing on the slopes and extremes in the various quantitative factors we monitor.
The chart above shows the correlations between the Nasdaq 100 and 10 year Yields, as well its correlation to the US dollar. Correlations allow us to understand how two markets have historical moved in relation to each other, and also how that relationship may be changing in the short term. By being focused on several different durations of time, we help ensure we aren't trading against a correlation induced headwind.
Bringing it all together
For us, the very best opportunities come when investors perception of a market diverges from that market’s Fundamental Gravity. These opportunities most often present themselves when a market’s Fundamental Gravity undergoes a shift from bullish or bearish to the other side…because investors are typically slow to recognize those shifts.