Dennis DeBusschere, Co-Founder and Chief Market Strategist, 22V Research
Nov 3, 2023
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Dennis DeBusschere, Chief Market Strategist at 22V Research, discusses the interaction between the economy, inflation, and the Fed's reaction function. He explores linkages between equity factors and macro variables like the yield curve. He also talks about hedging in an environment of unfriendly stock/bond correlation levels.
Understanding the relationship between the economy, inflation, and the Fed's reaction function is crucial for navigating market dynamics and policy decisions.
Defensive stocks and low-volatility factors do not provide safety during bear steepening, emphasizing the need for a diversified approach.
Analyzing the economy and market on a bottom-up basis, considering factors like demand, valuation, and monetary policy intent, is key for risk assessment and asset allocation.
Deep dives
Uncovering the Interaction Between Economy, Inflation, and the Fed's Reaction Function
In this podcast episode, Dennis DeBusher, the Chief Market Strategist at 22V Research, explores the process of understanding the relationship between the economy, inflation, and the Fed's reaction function. He emphasizes the importance of the Financial Conditions channel and explains that strong economic growth will force the market to confront longer-lasting policy. Dennis also discusses the linkages his team finds between equity factors and macro variables like the yield curve shape. One interesting finding is that defensive stocks and low-volatility factors did not provide safety during the recent bear steepening. Additionally, the conversation touches on hedging strategies in an environment of unfriendly stock-bond correlation levels.
Evolving Client Demands in the Investment Industry
Dennis DeBusher shares insights on the changing demands of clients in the investment industry. He explains that clients are now more macro-aware and smarter, requiring a deeper understanding of macro factors and their practical implications. The shift towards client-centeredness and trust in the relationship between researchers and clients is highlighted. Dennis also discusses the importance of providing research as a starting point, with deep relationships and conversations playing a vital role in helping clients make informed decisions and navigate complex market environments.
Framework for Risk Assessment and Asset Allocation
Dennis DeBusher provides an overview of his framework for risk assessment and asset allocation. He discusses the importance of analyzing the economy and the market on a bottom-up basis, examining factors such as underlying demand, valuation, and monetary policy intent. Dennis emphasizes that understanding the Fed's perspective and the intent behind their actions is crucial. He also highlights the significance of behavioral analysis in uncovering market narratives and identifying investment opportunities. Within the framework, Dennis mentions the attractiveness of the GARF factor (growth at a reasonable price) and its alignment with the current economic backdrop.
The Relationship Between Stock-Bond Correlation and Defensive Stocks
Dennis DeBusher examines the relationship between stock-bond correlation and defensive stocks. He notes that during periods of negative correlation between bond yields and stocks, defensive stocks such as utilities, staples, and pharma do not provide relative safety or outperform. This is attributed to their low dividend yields compared to a higher risk-free rate. Dennis explains that defensive stocks tend to be more attractive in recessionary environments. However, in the current backdrop of higher inflation pressures and higher debt-to-GDP ratios, the market favors early cyclicals, such as tech, discretionary, and communication sectors, which have performed better.
Navigating US Debt, Back-End Yield Movements, and Risk Off Episodes
Dennis DeBusher discusses the challenges posed by US debt, back-end yield movements, and risk off episodes. He acknowledges the concerns surrounding high deficits in the US peacetime economy and the unsustainability of running a deficit while having a low unemployment rate. Dennis explains that fiscal impulses lead to upward pressure on term premiums and inflation risk, contributing to the increase in 10-year yields. Concerns arise from the need to offset fiscal impulses with slower consumer spending growth. He also highlights the risks of higher rates and the potential impact on defensive factors and sectors in risk-off scenarios.
Game 5 of the 1973 NBA finals would be the last one played by Wilt Chamberlain, as the Lakers lost to a NY Knick team that featured basketball legends Walt Clyde Frazier, Earl the Pearl Monroe and Willis Reed. A fourth hall of famer, Dave DeBusschere, donning the number 22, also played an instrumental role in what was the last championship for the Knicks. 50 years later, his son, Dennis DeBusschere, is a co-founder and the Chief Market Strategist at 22V Research, a firm advising institutional clients on risk and asset allocation.
My conversation with Dennis explores his process for uncovering the interaction between the economy, inflation and the Fed’s reaction function. He emphasizes the importance of the financial conditions channel, asserting that economic growth that proves too resilient will force the market to ultimately confront policy that is higher for longer. A large part of our conversation is around the linkages that Dennis and his team find in various equity factors to macro variables like the shape of the yield curve. Of these, one interesting assertion is that defensive stocks and factors like low vol have provided little safety in the context of bear steepening. Lastly, we talk about hedging in an environment of stock/bond correlation levels that remain unfriendly. Here he points to a customized short basket he’s developed comprised of stocks with deteriorating short-term debt levels and high cash flow volatility.
I hope you enjoy this episode of the Alpha Exchange, my conversation with Dennis DeBusschere.
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