2022 was a long decline for major market indices - sorry passive investors.
The S&P 500 closed the year with a 19% loss and the Nasdaq was in deep bear market territory with a 33% loss on the year. Crypto also saw a major slump with flagships like Bitcoin and Ethereum crashing 63% and 37% respectively.
Almost across the board, this was a rough year for investors, unless, of course, you’re a trend follower.
Trend following stood out in 2022. Not only did it have better returns than the major indices, but the strategy made a ton of money for investors!
Here’s a look at some of the main trend following funds and indices out there:
- Societe Generale Trend Index: 27.2%
- Mulvaney Capital: 77.6%
- AQR Managed Futures HV Fund: 48.0%
- Chesapeake Capital Diversified Plus: 13.9%
- Chesapeake Capital Diversified: 17.8%
- Dunn Capital D’Best Futures Fund: 76.1%
Your loser in 2022 was up 13.9% - a pretty good year by most standards, let alone when you outperform the S&P 500 by 33%!
By any standard, 2022 was a great year for trend following. But why should we expect this success to continue into 2023?
Trend Following in 2023
Given that trend following has a centuries-long track record and that it is rooted in human psychology - which isn’t changing anytime soon - I don’t have any doubt that it will continue to perform well in the future.
Although there's always an element of uncertainty in any prediction, I do believe that trend following will continue to perform well this upcoming year for the following three reasons.
- Increased volatility
- Higher interest rates
- On-shoring and de-globalization
The world is more volatile than it has been in the past decade.
New international tensions have risen. New risks are in play. New technologies are making a profound impact.
All of these contribute to a continued increase in volatility across markets.
While many investors run from volatility - they love the comfort of those nice, smooth equity curves - volatility is great for trend following strategies. We need prices to move to have breakouts and if we’re positioned long or short, we don’t care which direction. Just get them moving and our systems will jump on board.
Many of the major geopolitical fissures that cracked in 2022 and led to things like soaring energy prices have not been resolved. This means we can expect a continuation of these trends in the near future.
Same goes for continued efforts to “green the economy.” This push shows no signs of slowing anytime soon, so a system that’s exposed to these sectors and underlying commodities stands to gain from continued trends.
Higher Interest Rates
The Fed has been hiking interest rates throughout 2022 reaching a 4.25-4.5% target in December 2022 - the highest it has been in nearly 15 years.
This leads to a wider valuation of equities and investments because analysts have a new variable to plug into their models.
When rates were pinned at 0 for most of the decade following the 2008 financial crisis, net present value calculations and discounted cash flow analyses had fewer differences across the industry. One of the key inputs - the interest rate - was decided for everyone. No need to forecast that anymore!
While the interest rate isn’t the only factor here, we’re seeing greater differences in valuations than we’ve seen in the past 25 years.
The key here is that as rates begin to move, interest rates, which underpin the pricing of everything in the economy, experience more volatility. This volatility leads to more trends, opening trading opportunities that have been suppressed over the past decade.
When governments around the world closed borders and limited travel in 2020, it caused massive disruptions for supply chains. Shortages appeared in consumer staples around the world and companies have taken steps to make their supply chains more robust to these disruptions. These attempts have taken many forms, but one of the primary forms is known as on-shoring.
On-shoring consists of reducing the interconnectedness of global supply chains by bringing production closer to the end consumer and making markets more local.
If, as many market participants predict, this leads to de-coupling of regional markets, we could see historic correlations break and have opportunities for further diversification as traders.
Additionally, these moves often come hand-in-hand with protectionist policies such as tariffs and trade restrictions. This may further increase dispersion among formerly tightly connected global markets.
We're living through a changing global order and trend following is a great strategy to survive and thrive in it.
Maximizing profits with trend following in 2023
If trend following teaches us anything, it's that trends continue on much longer than we anticipate.
It's not too late to make the most of this winning strategy.
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