Macro Index Spread Trading Strategy – Macroeconomic Trading
Last Updated on May 4, 2023
Most retail investors focus on companies’ fundamentals or valuations when deciding where to invest. But another important aspect to consider is in what context these companies operate: Is the economy growing or in a recession? What is the unemployment rate? Is inflation high? This is where macroeconomics enter.
Macroeconomic trading is one of the most difficult and challenging market trade methods. It involves going long or short on different assets based on informed notions about various countries’ macroeconomic and geopolitical developments. These strategies are mostly used by hedge funds and mutual funds, but retail investors can embrace them too.
In this article, we will look at what a macro index spread trading strategy is, who are the most famous macro investors, and explain the macro spread index.
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What is macro investing?
Macro investing consists of developing a strategy based on a country’s economic indicators and political views (geopolitics). This type of portfolio usually includes long and short positions in equity indices, currencies, commodities, and fixed income.
For example, suppose a hedge fund manager believes that the US is heading into a recession because, for example, the yield curve is inverted or the ISM manufacturing index is contracting. In that case, he might short the S&P 500 or go long safe assets such as Treasuries or gold.
However, macro models consider much more indicators than just the two mentioned above. They typically project different economic scenarios, make large-scale predictions about a specific country, or try to identify geopolitical trends.
One very famous macro investing strategy is a currency carry trade. Currency carry is when you borrow a currency from a country with low interest rates and convert it to another currency of a country with high interest rates, attempting to capture the difference between interest rates. The primary risk is the change in the exchange rate.
Famous macro investors
George Soros is probably the most known macro investor. He became famous after he gained $1 billion in a single day in 1992 by short-selling the British Pound. Although he is very well-informed, he admitted that his instinct plays a significant role in his investment decisions.
Another famous macro trader is Ray Dalio. He is the founder of Bridgewater Associates, the largest hedge fund in the world. Although the fund is multi-strategy, macro investing is a big part. Dalio recently released a book called “The Principles for dealing with The changing world order” where he explores countries’ economic cycles. Another of his best sellers is “The Principles for Dealing Big Debt Crisis”.
What is the Macro Spread Index?
The Macro Spread Index is a macroeconomic model that tries to predict future stock market returns based on macro indicators. The index shows the spread between the bear market probability model and the macro index model. Each model combines different economic indicators to give a read on the economy.
For example, the bear market probability model comprises five indicators: unemployment rate, ISM manufacturing index, yield curve, inflation rate, and the PE ratio of the S&P 500.
- The Relationship Between Unemployment and Stock Market Returns Explained
- ISM Manufacturing Index PMI – backtest
The higher the macro spread index is, the higher the odds of a significant decline in the stock market, usually combined with poor or deteriorating macro conditions.
However, it is essential to highlight that the model speaks to the odds more than the timing. The model says that macro conditions are worsening, and the stock market may be on the verge of a crash.
However, when this happens or if it happens is not certain. Timing the market is always the most challenging part. As we can see, the model did warn us about some bear markets in the past:
Macro Spread Index – Conclusion
To sum up, macro investing is hard, but it shouldn’t be dismissed (?). Developing a simple model like the macro spread index can help retail investors identify whether future market returns will be positive or negative. Moreover, it can help avoid huge losses by being more conservative when deteriorating macro conditions.