Global Macro Investing - terminology

HML factor

• represents the return spread between value stocks (those with high book-to-market ratios) and growth stocks (those with low book-to-market) ratios

global macro strategy

• an investing and trading approach based on the interpretation of major economic developments at the national, regional, and global levels

• fund managers analyse macroeconomic and geopolitical factors such as interest rates, exchange rates, international trade, political events, and global relations

fixed income securities

• investment instrument that provides a return in the form of fixed periodic interest payments and the return of principal at maturity

  • essentially loans by investors to borrowers, typically corporations/governments

• eg government bonds

• suitable financial instruments for risk-averse investors

• eg could have fixed income securities from US, Germany, Italy, Japan, UK

money market funds (short-term fixed income asset)

• maturity of less than one year

• investors typically hold to maturity

• less price fluctuation

• generally safe

longer-date fixed income funds

• cash flows are fixed

• changes in interest rates can cause significant price fluctuations

• potentially large losses in asset value

• longer duration implies greater price risk (duration risk)

equity

• represent ownership in a company (eg stocks)

• suitable for risk-loving investors

• eg S&P 500, NASDAQ, Euro Stoxx 50, Nikkei, Shanghai Composite, Hang Seng Index

magnificent seven

• seven US mega-cap companies:

• Apple, Microsoft, Amazon, Google, Nvidia, Tesla, and Meta

• account for over 20% of the S&P 500’s weight

commodities

• goods with minimal product differentiation and high fungibility

• eg oil, natural gas, gold, silver, copper, corn

drift

• long-run trend

derivative

• contracts whose value is derived from an underlying asset (eg currency, fixed income, equity, commodity)

• they are useful for hedging, speculation, and increasing investment power

futures

• standardized contracts to buy or sell an asset at a fixed future price

• eg the price of 1kg of gold one year ahead

options

• rights (not obligations) to buy or sell at a specified price

• can be thought of as an insurance contract: insuring against the asset price increasing

• if the price goes up, the buyer will receive a payoff

• can be bought (call) or sold (put)

Exchange-Traded Funds (ETFs)

• tracks a basket of assets and provide broad market exposure

VIX

• ETF that follows the volatility of the market

Russell 2000

• not micro firms but relatively small firms

• used for SMB investment strategies

S&P 500

• US biggest 500 firms

• dominated by tech and AI firms

macro style funds

• investment vehicles that seek to profit from the systematic risks of markets by analysing large macroeconomic events on national, regional, and global scales

• known for their flexibility and ability to invest in a wide range of assets worldwide

currency regime/exchange rate regime

• refers to the framework or system that a country’s government or central bank uses to manage its national currency in relation to other foreign currencies

fixed currency regime

• currencies that are pegged to another currency

• eg HKD (hong kong dollar) is pegged to the US dollar

• eg DKK (danish krone) is pegged to the euro

floating (frequent intervention) currency regime

• if the central bank feels that the currency is moving too much in the same direction, the bank will intervene

• therefore, the currency does not that much freedom

• eg Japanese Yen

floating (no intervention) currency regime

• currency is free to float

• eg USD, EUR

business cycle

• refers to how economic growth is not linear but instead, moves in cycles

• rises and falls over time

• however, there is an overall upward trend as the economy is getting richer over the very long-run, despite the fluctuations

• a recurring pattern of economic growth and contraction in an economy

economic expansion

• the upswing of the business cycle toward a peak

economic contraction

• the downswing of the business cycle toward a trough

natural output / potential output / full-employment GDP

• refers to the highest level of real GDP an economy can sustain in the long run without generating accelerating inflation

• ‘sweet point’ of growth

money supply

• total amount of money in circulation

velocity of money

• the rate at which money circulates in the economy

aggregate demand curve

• negative relationship between price and transactions

nowcasting

• the prediction of the very recent past, the present, and the near future of an economic indicator

  • traditional measures of output and inflation are typically released with a substantial lag

  • use high-frequency data to estimate current economic conditions such as looking at LinkedIn job posts for an estimated unemployment rate

black swan

• an event that comes as a surprise and has major effects

• characterised by their extreme rarity, severe impact, and the tendency to be rationalized in hindsight

economic shock

• causes deviations from an economy’s natural growth path

shock

• an unexpected event that disrupts the economic trend and can lead to booms/recessions

double dip recession

• when a short-lived recovery after a recession is quickly followed by another recession

• prevents the economy from fully recovering from the initial drop in economic activity

recovery

• a period of increasing economic activity

overheating

• occurs when the economy expands rapidly

stagflation

• characterised by weak or no growth alongside high inflation

contraction/recession

• inflation falls back to more sustainable levels while the labour market weakens

solow growth model

• explains how capital accumulation, population growth, and technological progress drive output and long-run growth

constant returns to scale

• scaling all inputs by a given proportion increases output by the same proportion

steady state (In solow model)

• as the marginal output from additional investment diminishes with higher levels of capital, while the cost of investment remains unchanged, the economy eventually reaches a point where benefits equals costs

mega forces

• overarching themes influencing investment decisions

life cycle hypothesis

• suggests that individuals save during their prime working years in order to finance consumption in retirement

labour productivity growth

• more output per hour worked

efficient market hypothesis

• public available information will be reflected into stock price instantaneously

• assets prices reflect all available information at any point in time

• may be reflected in the evening for the UK (outside UK’s opening hours) but it is opening hours for Asian markets so these stocks will reflect any information immediately and it will be shown for the UK as soon as the markets open for them

central bank

• a national bank that provides financial and banking services to the government and the commercial banking system

• acts as the banker to both

Federal Open Market Committee

• the branch of the Federal Reserve System responsible for setting monetary policy, primarily through open market operations

• on committee, there are 12 Reserve bank presidents and 7 governors (19 people)

• for voting, only 5 reserve bank presidents and 7 governors (12 people)

  • the president of the Federal Reserve Bank of New York always votes

  • the other four rotate

hawkish

• focus on controlling inflation rate by raising interest rates, even if it affects growth and employment

• more concerned about inflation stability over short term economic gains

• impose a higher interest rate to ensure price stability

blackout period

• from the Saturday before the meeting until the following Thursday, officials of the Fed Committee cannot speak publicly

lender of last resort

• typically a central bank that provides emergency liquidity to financial institutions facing severe liquidity crises to prevent economic disruption

haircuts

• refers to the percentage reduction applied to the market value of an asset when it is used as collateral for a loan or for assessing capital requirements

• helps lenders manage risks associated with market fluctuations and borrower defaults

discount window

• a tool that the Federal Reserve uses to increase the stability of the financial system

  • some believe its effectiveness is diminished by stigma: institutions may avoid borrowing from it out of concern that they may be perceived as being in weakened financial condition

  • The Bank Term Funding Program valued collateral at par, helping to reduce stigma

quantitative tightening

• aims to contract money supply to control inflation and stabilise the economy

• by reducing the amount of money, QT seeks to increase interest rates which makes borrowing more expensive and reduces consumer demand

• central bank may sell government bonds or other financial assets they hold to directly reduce the amount of money in circulation

  • may allow bonds to mature without replacement

• the central bank runs off long-term securities without repurchasing so the balance sheet shrinks

dovish

• more supportive of the economy

• impose a lower interest rate to promote employment

unanchored (inflation expectations)

• people don’t believe the long-term inflation rate will be 2%

anchored (inflation expectations)

• individuals believe that this is just a temporary price increase and the long-run inflation rate will still be 2%

treasury inflation protected security (TIPS)

• it is a treasury bond that is inflation adjusted

  • its yield is real (net of inflation)

• adjust coupon rate by the CPI data

• realized inflation will be reflected in prices

• TIPS yield is typically 1.8%

quantitative easing

• when the Fed (central bank) buys treasuries in the market in the hope to reduce interest rates and make lending cheaper

• it reduces interest rates by increasing the bond price

employed

• includes only adults (16+)

• worked for pay, in own business, or unpaid in family business

• includes those temporarily absent from a job

unemployed

• includes only adults (16+)

• not working, available for work, and actively searched in the past 4 weeks

not in the labour force

• includes only adults (16+)

• neither employed or nor unemployed

  • eg students, retirees, discouraged workers

non-farm payroll

• represents the number of new jobs added per month

• covers about 80% of the labour force

• shows how many jobs are added to the non-farming sector

wage-price spiral (inflation)

• higher wages → stronger demand → higher prices → further wage demands

  • this feedback loop can generate persistent inflationary pressure

• when inflation increases, workers ask for higher wages, which results in higher inflation (creates a vicious cycle of inflation)

headline inflation

• includes ALL items

• food and energy are highly volatile

core inflation

• excludes fuel and food to provide a more stable signal

  • alternative to this is the trimmed mean, which removes extreme price changes to better capture the underlying inflation trend

tapering

• a reduction of the Fed’s asset purchases as an attempt to reduce inflation

nominal

• observable in the market

ex-ante

• expected

• looking into the future, what we predict

ex-post

• realized

• actually observed

break-even inflation rate

• difference between the yield of a nominal bond and an inflation-linked bond of the same maturity (eg TIPS)

• viewed as a more reliable measure of inflation expectations than those measured by surveys

R*

• equilibrium real interest rate = natural rate

• not controlled by central banks

• key benchmark for monetary policy

• not constant and evolves with economic fundamentals

data dependence

• rather than the Federal Reserve targeting an exact rate, they typically adopt a gradual, trial-and-error approach to deal with inflation

  • they adjust policy step by step

  • observe incoming data and market reactions

  • recalibrate as needed

yield curve

• plots bond yields against their maturities, holding credit quality constant

• x-axis: time to maturity

• y-axis: yield

term premium

• the extra compensation investors demand for bearing duration (interest-rate) risk

liftoff

• policy rate rising from zero

DV01

• measures how much a futures price changes for a 1bp move in the yield

• a type of fixed income security

G20 economies

• relatively highly developed economies

short position

• when a trader borrows shares of a stock/security from another investor and immediately sells them on the open market at the current price

• the trade now has an obligation to return the same number of shares to the lender at a later date

• the goal is to repurchase the shares at a lower price, return them, and pocket the difference as profit

policy trilemma

• the issue that a country can only achieve two out of three policy goals:

  • free capital mobility

  • exchange rate stability

  • independent monetary policy

• all three cannot be maintained at the same time

European Exchange Rate Mechanism (ERM)

• aimed to reduce exchange rate volatility before the introduction of the euro

• members were required to keep their currencies within agreed fluctuation bands

discretionary trades

• take a view on the movement of an asset

• eg: long copper expecting prices to rise

relative value trades

• exploit differences between related assets

• profit from changes in their price relationship

• eg: long (buy) german bonds, short (sell) italian bonds during the european crisis

event-driven macro

• position for major macro/geopolitical events

• eg: trading around brexit outcomes

contrarian returns

• refers to the potential of an investment strategy to generate returns that are opposite to the prevailing market sentiment

• ie, investors profit from market inefficiencies/mispricing

• look for undervalued/overvalued assets

• contrarian profits can be explained by the Fama-French (1993) three-factor model as investor will invest in small, undervalued stocks which the model predicts can lead to some benefits

momentum returns

• buying stocks that have had high returns in the past few months and selling stock that have had low returns

factor investing

• refers to a strategy that goes beyond the traditional capital asset pricing model (CAPM) by considering additional firm characteristics that can explain asset returns

risk parity strategy

• allocates capital based on each asset’s risk contribution, not market value or expected return

• aims to balance risk across assets to improve risk-adjusted performance

backward-looking information

• information you can extract from historical data

  • can take a long time to compile the relevant information

  • may be obsolete by the time you receive the information

• helps us to understand what is going on

• ex-post

• more accurate than forward-looking

  • more reliable as well as it is not based on some uncertainty in the future means we can’t use it to predict too far into the future

• as it is based on historical data, it doesn’t give predictions of the future

risk-off

• defensive strategy

forward-looking information

• data, analysis, or indicators that provide insights into future market conditions, trends, and potential outcomes

• help investors and businesses make informed decisions based on anticipated future developments

  • crucial for us to understand what has been priced in

• forward looking, but they are based on information in the past

  • ie, we care about whether the realized earnings is sustainable in the future, not what the past earnings were

• market outlook on earnings and other indicators is consistently updated

  • the change in forecasts contains useful information (ie tells us if they expect the market to do better/worse than initially expected)

term structure

• refers to the relationship between the prices of derivatives on the same underlying asset, but with different expiration dates

forward price

• prices of derivative contracts (such as futures)

options

• like insurance for asset price movements

  • insurance for upward movements = call

  • insurance for downward movements = put

• investors can buy and sell these products at different strike prices

• compared to simply buying/selling an asset, options are more complex products and preferred by many investors

option implied volatility

• fear gauged

• using option prices to extrapolate the market implied volatility

VIX index

• otherwise known as ‘fear gauge’

• measures the market’s expected volatility over the next 30 days

• widely used to assess market risk, stress, and uncertainty

• derived from prices of a wide range of S&P 500 index options (calls and puts)

• therefore, it is forward looking

volatility smile

• a curve showing higher implied volatility for options far from the money

• reflects the market perceptions of higher risk for extreme price movements in the underlying asset

  • this indicates that traders pay a premium for options at extreme strike prices

  • similar to buying insurance: willing to pay a higher premium to insure against low-probability events that could lead to severe loss

short squeeze

• a rapid increase in a stock’s price caused by short sellers rushing to cover their positions, creating a feedback loop of buying pressure

bid-ask spread

• simple indicator of liquidity

• difference between bid and ask

• narrow spread = high liquidity, easier to trade

• wide spread = low liquidity, high liquidity risk

bid

• highest price a buyer is willing to pay

ask

• lowest price a seller is willing to accept

confirmation bias

• investors seek out information that confirms their existing beliefs and ignore/undervalue information that contradicts them

• they seek or interpret evidence in ways that are partial to existing beliefs