The macro economy has cyclical fluctuations, and asset prices have different performances in different stages of the economic cycle. The traditional Merrill Lynch investment clock analysis method is to give asset allocation recommendations by studying the economic cycle. The author’s research found that based on the Merrill Lynch investment clock analysis framework, by constructing leading indicators of economic growth as a substitute variable for the output gap, and then conducting investment analysis and formulating investment strategies, it is helpful to obtain higher investment returns.
Construct leading indicators of economic growth to distinguish different stages of the business cycle
The traditional Merrill Lynch investment clock analysis framework has a basic assumption: changes in economic growth (expressed by the output gap) lead changes in inflation. According to changes in economic growth and inflation, the business cycle is divided into four phases, corresponding to different quadrants: the period when economic growth rises and inflation falls is the recovery period, corresponding to the first quadrant; the period when both economic growth and inflation are rising is the overheating period , Corresponding to the second quadrant; the period of economic growth down and inflation rising is the stagflation period, corresponding to the third quadrant; the period of economic growth and inflation both falling is the recession period, corresponding to the fourth quadrant. At each stage, there is a class of asset yields that perform best. Among them, bonds perform best during recession periods, stocks during recovery periods, commodities during overheating periods, and cash during stagflation periods (see Figure 1).
Considering that the availability and timeliness of output gap data restricts research, the author constructed a leading indicator of economic growth as a substitute variable for output gap analysis. According to the leading, synchronous and lagging relationships of various economic data sub-items, the real estate funding sources, commercial housing sales, automobile production, manufacturing purchasing manager index (PMI) new orders and finished goods inventory difference, narrow money supply (M1 ), the year-on-year growth rate of financial institutions’ loan balances to the real economy as the leading economic indicators; the crude steel output, cement output, power generation and industrial added value on the production side, the total retail sales of consumer goods and fixed asset investment on the demand side, and the price side The year-on-year growth rate of data such as the consumer price index (CPI) and the factory price index of industrial producers (PPI) is used as a synchronization indicator. The deflator is the most effective in measuring inflation, but there is a certain time lag. Therefore, the composite index of CPI and PPI is used to measure the overall inflation level.
When synthesizing economic leading indicators and synchronized indicators, the cycle items after eliminating the period items are used to construct, and the quarterly smoothing process is performed at the same time to eliminate the influence of abnormal values in individual months. Figure 2 shows the trend of the synthesized economic leading indicators and synchronized indicators. As can be seen from Figure 2, from the perspective of the time window for identifying the turning point, the time window of the leading indicator is earlier than that of the synchronized indicator. At the same time, the fluctuation of the leading indicator is relatively more obvious and easier to identify when the economic growth volatility narrows. For example, in December 2020, the synchronization indicators are still in an upward state, but the leading indicators have shown signs of peaking.
Based on the statistical data of leading economic indicators and inflation indicators, the author has determined the specific stage of my country’s economic cycle since 2005. The overheating period is mainly from July to September 2007, from December 2015 to April 2016, and from August to October 2016. The stagflation period is mainly from March to June 2010, from November 2010 to May 2011, and from May to July 2016. The recession period is mainly from April to June 2005, September to December 2014, and October 2018 to February 2019. The recovery period is mainly from February to May 2006, from December 2008 to August 2009, from June to November 2012, and from May to November 2015. Since April 2020, my country’s leading economic indicators have bottomed out, and inflation indicators have continued to decline slowly, in a period of typical economic recovery (see Figure 3).
Back-testing of various asset returns based on leading economic indicators
(1) Back-testing of return on major types of assets
Based on the economic cycle divided by the aforementioned economic leading indicators, the author conducts a back-test on the return on various assets. In consideration of data availability, the inspection window is set from March 2005 to October 2020, and the Shanghai Composite Index, ChinaBond-Total Wealth Index, Wind Commodity Index and Money Market Fund Index are used respectively. Calculate the return on assets of stocks, bonds, commodities and cash (see Table 1).
Under the investment clock analysis framework constructed based on leading economic indicators, the ranking of various asset returns in the recovery period, overheating period, stagflation period, and recession period is slightly different from that under the Merrill Lynch investment clock analysis framework (see Table 2). Generally speaking, during the recovery period and overheating period when leading economic indicators are rising, the yields of commodities and stocks are better, while bond yields are not good; during stagflation and recession periods when leading economic indicators are falling, bond yields are better. Stock yields are not stable enough, and commodity yields are poor.
(2) Back-testing of various subdivided assets
On the basis of the inspection of large-scale assets, the author further tested the performance of sub-asset yields in different stages of the economic cycle, and based on this, the choice of stock industry and bond maturity selection. Here, the investment yield of Shenwan’s first-level industry and the yield of ChinaBond-total wealth index of different maturities are used as the test objects.
At different stages of the economic cycle, the performance of investment returns in various industries is very different. For example, in the stage of economic recovery, among the 28 first-level industries of Shenwan, the 10 industries with outstanding investment income are electronics, non-ferrous metals, food and beverage, pharmaceuticals and biology, commercial trade, real estate, mining, automobiles, household appliances, and national defense and military industries. .
From the perspective of bond market investment, different duration strategies can be adopted at different stages of the economic cycle. During stagflation and recession periods, bond durations should be extended; during recovery and overheating periods, bond durations should be continuously shortened. The current stage of economic recovery, taking into account coupons and capital gains, the 5-7-year China Bond-Total Wealth Index performs best (see Table 3).
Major asset allocation strategies based on leading economic indicators
(1) Major asset allocation strategies
Based on the analysis of the yields of major assets at different stages of the economic cycle, the author has formulated different asset allocation strategies: allocate bonds during the recovery period and overheating period, increase equity allocation positions; during stagflation and recession periods, reduce equity allocation positions, Increase the allocation of bonds and cash. The specific allocation positions are shown in Table 4.
Based on a back-test of the investment yield of my country’s capital market in the past 15 years, the annualized yield of the above-mentioned major asset allocation strategies is 5.88%, the annualized volatility is 3.2%, and the Sharpe ratio is 1.06, which is better than stock investment and bond market investment. , The Sharpe ratio of the traditional stock-bond hybrid strategy (the allocation ratio of stocks and bonds is fixed at 1:4) has increased significantly (see Table 5 and Figure 4).
(2) Allocation strategy of subdivided assets based on the superposition of major types of assets
Based on the performance of subdivided asset yields, the author added industry selection and duration strategies in the allocation of major types of assets, concentrated equity positions at different stages of the economic cycle in the most promising 10 industries, and concentrated bond positions on specific durations. Further optimize the configuration strategy. The results of back-testing show that the annualized return rate of the asset allocation strategy of superimposing subdivided assets has further increased to 7.31%, the volatility rate is 3.8%, and the Sharpe ratio has further increased to 1.25, which has further advantages compared with the traditional equity-bond hybrid strategy. It appears (see Table 6 and Figure 5) that the optimal allocation of investment strategies is more effective.