A Focus on Alpha & Strategy

The following pages contain 4 things: 1) 2)

Steven Morales: Private and Confidential

3) 4)

Alpha generators Excerpts from strategy presentations made to clients over the last few years that are based on personal (in-house) proprietary research Dashboards Optimization tools

A Focus on Alpha & Strategy

1) The Alpha generators:

These are visual basic work environments that allow for uploading any data series, such as a macroeconomic data, and using simple transformations, search for and rank the best drivers for a given asset. These relationships can be simple ways to produce forecasts.
Steven Morales: Private and Confidential

Simple examples: one could set up an experiment to find the most relevant macroeconomic data for predicting the price of the S&P 500 6 months forward or the price of Oil 6m forward. Any asset can be analyzed. Any question can be considered. Key takeaways: 100s of drivers may be considered at once. Lesser known but valid relationships between fundamental data and markets can be found, helping to find some structure in otherwise incoherent market behavior, 100s of forecasts can be made at once, i.e. automated for consideration, discussion, visual representation of ideas, clear, repeatable methodology,

A Focus on Alpha & Strategy

1) The Alpha generators: Macroeconomics vs Assets: The research process ranks drivers in terms of relevance to create or show interesting relationships. Once those relationships have been chosen by the portfolio manager a series of forecasts can be created for each asset.

Steven Morales: Private and Confidential

Example: Forecasting the S&P 500, ranking indicators, multiple forecasts and probability distribution

Steven Morales: Private and Confidential

Example: Forecasting the S&P 500, ranking indicators, multiple forecasts and probability distribution

Steven Morales: Private and Confidential

Steven Morales: Private and Confidential

Steven Morales: Private and Confidential

Steven Morales: Private and Confidential

Steven Morales: Private and Confidential

A Focus on Alpha & Strategy

1) The Alpha generators: Company fundamentals for forecasting forward stock returns A core group of company metrics, such as earnings growth, sales growth, ROE, dividend growth can be used to adjust valuation and then forecast share price returns.

Steven Morales: Private and Confidential

The model chooses between multiple multifactor models based on simplicity and reliability.
Key takeaways: large caps stock returns are many times dictated by simple metrics, however, each company (Cisco vs Intel) may be sensitive to different factors and to different degrees. Automating this process of determining direction and magnitude for expected returns across an equity universe is extremely important and easy.

A Focus on Alpha & Strategy

Forecasting share prices using P/L metrics and valuation

Example: Apple Computer

Steven Morales: Private and Confidential The red line is the model prediction of Apples 6m forward return. Here it is observed that a slowing of share price returns was coherent with the rate of the change of the basic fundamentals of the business even back in early 2012.

A Focus on Alpha & Strategy

Fundamentally driven return expectations can be produced in mass, for comparison and discussion

Steven Morales: Private and Confidential

A Focus on Alpha & Strategy

1) The Alpha generators: Optimal return portfolios and management Clients should expect to receive asset returns adequately compensated for risk.
Steven Morales: Private and Confidential

Eliminating or tactically hedging portfolios and assets during periods of bad future risk reduces volatility and is a valid profit hoarding strategy. These models identify key volatility levels for assets: stocks, bonds, etfs, commodities, currencies, asset pairs, etc. Key takeaways: these models are not asset selectors but asset managers, the tactical hedging frequency is medium 12x per 5 years, the exponential cumulative wealth effects of reducing exposure during periods of bad volatility are impressive. The tactical hedging signals can be generated for an entire universe of assets. Monte Carlo stress testing suggests that this strategy is a good one, but definitely not the holy grail

A Focus on Alpha & Strategy

Optimal return models for any asset

Steven Morales: Private and Confidential

Tactical Hedging: clear and simple profit hoarding methodology for stocks, bonds, etfs, commodities, currencies and pair trades.

A Focus on Alpha & Strategy

2) Strategy excerpts: 2009 2013 The macroeconomic alpha generators or financial markets relationship analyzer has been a great source of idea generation and generalized clarity in a many times confusing market place for investing and discussion.

Steven Morales: Private and Confidential

However, the key to a coherent strategy have not always required original or complicated explanations. The December 2012 message to clients was all about,
Fed liquidity support of asset prices could be counted on given the still high levels of structural unemployment in the United States, keeping GDP below potential and variations of the Taylor suggested -400 bp of easing was probably in order.

A Focus on Alpha & Strategy

2) Strategy excerpts: 2009 2013 Even so, one of the more interesting strategy pieces I wrote and spoke about near the end of the 2009 crisis was based on a new model I had made for forecasting core inflation. Intuition, curiosity and research showed that potentially the future shape of everything was based, directly or inversely, the shape of future inflation. The topic at the time was deflation and forecasts showed it was improbable, already, but that stocks prices might flatten as a consequence.

Steven Morales: Private and Confidential

Next 18 months core Inflation forecast

Steven Morales: Private and Confidential

Strategy excerpts: 2009 2013

Steven Morales: Private and Confidential

Strategy excerpts: 2009 2013

A Focus on Alpha & Strategy

Strategy excerpts: 2009 2013

Steven Morales: Private and Confidential

Against All Odds - Mild Recovery and Election Year Supports Mild to Good Returns and Lower Risk in 2012
US Macroeconomics
Investment Policy Inspite of stable earnings and risk, sector and stock selection 1H 2012 should still recognize the following risks: 1) the global slowdown, 2) financial system risk and 3) the possibility of only range bound markets 1H. S&P p.obj: 1359

Steven Morales: Private and Confidential

Investments

Stable to impoving company earnings, normalized credit conditions, cash returns to shareholders (buybacks and dividends) a better housing market, a comitted Federal Federal Reserve (QE3 / GDP Targeting), and a positve wind from the Election year all support a stable risk environment and mild (1H) to good (2H) stock market returns

Macro

Against all Odds the U.S. Economy is recovering mildly but consistently in the face of a global slowdown and important financial systemic risk from Europe

Sectors and Stocks Until evidence of further monetary and political support: Underweight Financials, Commodities Overweight: Stable Growth

Strategy excerpts: 2009 2013

Against All Odds - Mild Recovery and Election Year Supports Mild to Good Returns and Lower Risk in 2012
Growth
Steven Morales: Private and Confidential Business activity, GDP, leading indicators, lending conditions, housing PLUS corporate cash returns

Systemic Risk:
Financial Risk indicators are showing alarm bells, even as macoeconmic contiions improve, thanks to the crisis in Europe

I) Mild Growth & Corporate Action III) Policy Action (Fed)

II) Systemic Risk from Europe

IV) Presidential Cycle

Policy Action:
Fed recognizes the need to improve economic conditions further (QE3, GDP targeting)

Presidential Cycle:
A better and well supported economy could help Obama return to the White House. Worst case, less grid lock in Washington.
Strategy excerpts: 2009 2013

Against All Odds - Mild Recovery and Election Year Supports Mild to Good Returns and Lower Risk in 2012
NBER Business Cycle (+) Steven Morales: Private and Confidential Business Conditions (ISM, Philly Fed) (+) Leading Indicators (Conf Board) (+)

GDP and Components (+)

Unemployment (+)

Credit Supply (Lending) (+) Demand (-)

Confidence (+) Housing (+)

Personal Income (+) Expenditures (-) Savings (+)

Inflation Expectations (+)

Macro Matrix showing improvements accross the board

Strategy excerpts: 2009 2013

Steven Morales: Private and Confidential

Strategy excerpts: 2009 2013

Steven Morales: Private and Confidential

Strategy excerpts: 2009 2013

Steven Morales: Private and Confidential

Strategy excerpts: 2009 2013

Against All Odds - Mild Recovery and Election Year Supports Mild to Good Returns and Lower Risk in 2012

Steven Morales: Private and Confidential

Consumer confidence vs S&P 500

Strategy excerpts: 2009 2013

Circle puzzle Against All Odds - Mild Recovery and Election

Year Supports Mild to Good Returns and Lower Risk in 2012

Steven Morales: Private and Confidential

ISM New Orders is inversely correlated to Pharma (-0.82)

Strategy excerpts: 2009 2013

Circle puzzle Against All Odds - Mild Recovery and Election

Year Supports Mild to Good Returns and Lower Risk in 2012

Steven Morales: Private and Confidential

Strategy excerpts: 2009 2013

Circle puzzle Against All Odds - Mild Recovery and Election

Year Supports Mild to Good Returns and Lower Risk in 2012

Steven Morales: Private and Confidential

Expect Stocks to Beat Bonds by 10%

Strategy excerpts: 2009 2013

Circle puzzle Against All Odds - Mild Recovery and Election

Year Supports Mild to Good Returns and Lower Risk in 2012

Steven Morales: Private and Confidential

Expect Stocks to Beat Bonds by 10%

Strategy excerpts: 2009 2013

A Focus on Alpha & Strategy

3) Investment Dashboards Dashboards are useful for visualizing strategy and showing even a large array of forecasts
Steven Morales: Private and Confidential

Steven Morales: Private and Confidential

Investment Dashboards

Monitoring global indices

Steven Morales: Private and Confidential

Investment Dashboards

A Focus on Alpha & Strategy

4) Optimization Tools Research into developing interesting metrics measuring the smoothness of returns when comparing trading strategies was useful for the much simpler task of portfolio min var optimization.
Steven Morales: Private and Confidential

Portfolio Optimization
Targeting beta, ir ratio, smoothest return, alpha slope etc, sector weight ranges or any other desirable metric

Steven Morales: Private and Confidential

Optimization Tools