After significant, robust research, I identified the economic data points that I felt were most relevant and significant to the current state of the U.S. Economy. It was a simple approach that was aggregated efficiently in spreadsheets, but it gave terrific guidance to allocation decisions. This approach was responsible for navigating adverse market moves in the 90’s and during the 2001/2002 recession. It was originally called the USEI.
One of the greatest compliments I received was from a long time friend and hedge fund manager John Eckstein III. He once told me the USEI was ”brilliant in its simplicity.” That began a partnership that resulted in John becoming the CIO and co- creator of the AEI (Astor Economic Index). John took the premise and the track record it produced and made it more robust, using more sophisticated coding and computer input. While we are all fascinated by machine learning and AI and run many programs that incorporate it, we have not yet found that it enhances our original thesis and results. As more time and more data are produced, this could change. John Eckstein and I continue to monitor all economic data to determine if we should include any new datapoints in to the Index. However, we don’t make changes to the index frequently because we believe that the main pillars of economic health, output and employment, remain fairly constant.
Hortz: With your emphasis on “now-casting,” do you see us near any major shifts or inflection points from the economic data you are seeing?
Eckstein: As we’ve said, using the AEI we can engage in “now-casting”—not forecasting—the U.S. economy to help us determine when it’s most advantageous to hold risk assets such as equities. Throughout 2019 we have seen growth moderating. After a prolonged period of “above average growth”, the AEI reading shows economic growth is currently about “average.” That’s certainly lower than the growth we’ve seen in the last 10 years. Just because growth is less robust than in the past, we can’t (and won’t) jump to the conclusion that we’re headed into an economic contraction and a market downturn.
An “average” reading for the economy still suggests a positive return for stocks. It just comes with more risk. That said, “average” is just one mouse click away from below-average growth at which expected returns are less positively sloped. Recent data readings such as GDP, ISM and even Jobless Claim—collectively, the foundation of the economy—are showing a struggle to break away from long-term averages. Employment, of course, has been exceptionally strong over the long-term average (over the past 5 years or so). However, even there, the longevity of the trend means that when minor weaknesses are first detected, they’ll likely have a bigger impact. This is what is unique about the way that Astor looks at economic data—on a relative basis over long-term averages.
Hortz: The second major area that you have been navigating through is the ETF landscape. You have strictly been executing your investment process through using ETFs since 1999. As an experienced ETF strategist, what have you found to be the best advantages and key pitfalls of using ETF’s to execute your portfolio construction for your clients?
Eckstein: We believe that the instrument for best accomplishing true diversification in portfolio construction—through both bullish and bearish cycles—is the ETF. These instruments are a pure play on a specific index or sector. The transparency and low expenses of ETFs make them ideal investment choices for our macroeconomic approach. In fact, Astor’s founder Rob Stein has been on record as saying the ETF is the great financial product innovation since the creation of the put option. ETFs give investors and portfolio managers alike flexibility in establishing long and short positions easily by buying an instrument, with the ability to use specialized ETFs to be long or short a particular sector or industry.
That said, using ETFs to invest means that you won’t get the sky-high returns from picking that rare stock with gains that outpace all the other issues in the sector with an ETF, you’re getting a basket. Getting a representative return of across multiple holdings makes the ETF a perfect instrument for pursuing our goals of true diversification to achieve less volatility, long-term capital appreciation, and lower drawdowns—and, over time, a more stable risk/return curve than our benchmark.
Stein: The more participants that interact with a product or idea, the more resources and ideas will be further applied to enhance that system to either bring it further to scale, improve value or make it more efficient to use. All of these have been happening in the past 10 years in the ETF market.
Traditionally, ETF issuers have launched product to track index methodologies in passive “exposure” products, covering everything from the broadest market to the many sub-sectors to emerging market countries. For years, ETF issuers took turns at products to track the many indexes available.
As the “white space’ filled across the investable markets, issuers and other investment firms took a turn to enhance exposures, testing and creating quantitative indexes that would make up the next phase of ETF growth. Their features look to improve upon traditional screening methodologies and offer a more advanced or smarter way to index.