I cannot state how important the following is —>
Whenever you have a discussion with somebody that tells you his or her stock is great tell him or her, that the stock has only around 20% alpha and the rest is in the market and in the industry driven by macro (rate of change of GDP, Inflation and Fed Policy).
But we could also argue the following:
As long as you look at what is relativly weak and what is relativly strong, you have an implicit macro overlay, e.g. you look at the factors (value, momentum, growth, size etc.) that are driven by macro.
At the end its about price momentum.
But in order to find out what is strong and what is weak right now you have to have a view into the market.
So what should we watch at least once a week? The tape.
An example:
HYG (High Yield Growth Bond ETF) —> weak, one point for Risk off (strong would be one point of risk on).
EWG (German Stock ETF) —> weak, one point for risk off
VXX (Volatility) —> making higher highs, one point for risk off
GXC (China) —> weak, one point for risk off
SPY, IWM, QQQ —> all weak, one point for risk off
Dollar —> strong, one point for risk off
Mid to Big Cap High Beta —> weak, one point for risk off (for that you could use ARKK, which is even much weaker than my following model).
Small Cap Value Momentum: very strong (one point for risk on, small cap value momentum is strong if inflation is trending up, so one point for inflation exposures). I use my systems for this, but you could also have a look at XSVM (which is relative strong right now too, not as strong as my model, but you get the idea…):
External Risk event, yes or no (something like COVID, Banking Crisis, War etc.) —> Yes, we have an external risk event: War in Europe: 1 Point for risk off.
I could go on with the above list but would not add much more utility to it.
My point is, being macro aware and determining in what stage the market is by looking at price trends is not that hard.
Be long stuff that has relative strength
If the tape is weak (just add the points from above), hedge your long book
Now, if you look at the above list, do you think it takes much to drag down small cap value momentum (which is strong right now) to a 50% drawdown from here?
No, it does not take much at this stage of the market (as soon as inflation fades, they will tank very hard!). Based on the above list risk off has 8 Points right now, risk on has 1! We are in a risk off regime and bad things happen in a risk off regime.
My list is a bit longer because I also look at the capital curves of my trading system, but I come to the same conclusion as the above list.
Just do not fall into the trap, that a good company is a good stock, or a good stock is a good stock at all times.
And have fun building your own list! Ask yourself what needs to be strong to define a risk on or risk off market.
Exactly a market is a place where people come to buy and sell. If they don't have the money to buy(inflation) or the product to sell(growth) then the market can not do well at what it is designed to do. Now if the company can't get sellers to buy their product they can not grow. They have to decrease spending and cut employees to make up for the lost of revenue. This leads to missed goals. Economics explained in paragraphs haha good write up.