Bill Hortz's picture

[We are in a puzzling investment environment. Warning signs abound. Uncertainty and fears of recession have investors and advisors climbing that wall of worry as markets continue to reach new highs. It keeps begging the question: How do you navigate an environment such as this?

The Institute was recently introduced to Rob Stein, Founder & CEO, and John Eckstein, CIO, of Astor Investment Management – a Chicago-based registered investment advisor that keeps a rather unique finger on the pulse of the economy and the ETF landscape. Rob Stein, with his experience at the Federal Reserve and senior positions at large money center banks has developed a tool – the Astor Economic Index (AEI) - to “now cast” versus predict the economy. Through a robust proprietary data-driven macroeconomic approach, their research and investment knowledge can greatly add to the industry discussion on this navigation question and help advisors on defending their clients’ portfolios. ]

Hortz: Why are economic data and a macro approach the core of your investment philosophy?  

Stein: Our research over many decades has proven—and continues to prove—that increasing exposure to risk-bearing assets, like equities, during positive economic environments (expansions) and decreasing exposure during negative environments (contractions) have the potential to be extremely productive for portfolio construction and management.  Through our economics-based, fundamentally driven approach, Astor has amassed a successful track record. Most importantly—and as happened in late 2007 before the financial crisis hit—by being data driven, we were able to avoid steep losses and help clients mitigate the impact of wealth destruction in their portfolios. As a result, they were better positioned for growing their portfolios as opportunities to invest emerged.

Hortz: How do you cut through misinformation or confusing economic periods where definitive trends or direction are not determinable?

Eckstein: The problem isn’t with the data—it’s what some people try to do with it. Namely, the problem is in prediction. The problem with forecasting is that it’s very easy to get wrong. It’s like the old joke that economists were created to make weather forecasters look good. We have stayed true to our analytical roots. Rather than trying to predict what is going to happen, we find it much more impactful to review and analyze economic data in real time to determine what is currently happening. To do this, we look at the economic data in aggregate to determine the current strength or weakness of the economy and manage our portfolios accordingly.

Hortz: Tell us about your proprietary Astor Economic Index – what it comprises and how you use it?

Stein: The Astor Economic Index or AEI provides us with a real-time “window” to the economy. The AEI aggregates data from across the U.S. economy as a systematic analysis of various employment and output data (GDP, ISM, etc.) to say where the economy is today. By aggregating all economic data into a single value, we can then compare today’s economy reading to historical averages and absolute historical levels to determine the relative strength or weakness of the economy, in real time. The AEI allows us to keep our finger on the pulse of the economy and to manage our portfolios accordingly.

Hortz: How did you go about constructing your index and how do you continue to develop it?

Stein: The concept/idea of the Astor Economic Index® was really born during my time served as a project analyst at the Federal Reserve and my time spent on trading desks at large Wall Street money center banks. Economic data was generally released in the mornings and fed open market operations were conducted every day, if needed, in the mid-morning.  Once a week on Thursday afternoons, the traders would wait around for the latest money supply data. I noticed markets would make short term moves that the traders welcomed but it was not consistent with the movements over the next few weeks or months.  I started to keep track of the data every day in a note book with graph paper. Eventually I used a computer and a program called Lotus 123.  The one thing I noticed was the short term moves were not always consistent with the direction of the data.  Sometimes good data produced negative results in the markets and vice versa.  I found that extremely interesting and it led me down the path of analyzing longer term trends in the data and not any individual data point.  It eventually became clear that data consistent with why an economy grows, such as employment data and what an economy produces, its output like GDP, were more predictive of the longer term direction.  This was the Eureka moment that began my research into identifying the trend in economic data that supported trends in markets and not trying to identify short term moves.

After significant, robust research, I identified the economic datapoints 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 Claims—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.

Hortz: Any last advice you can share with advisors on how to navigate the markets from your economic and ETF landscape knowledge?

Stein: We at Astor are keeping a very close watch on stock market movements and economic data in real time—as we always do. By using ETFs, we can create portfolios that give investors specific exposure to asset classes that our models suggest.  We can reduce, increase and even create exposure that once could only be achieved with stocks which made it challenging to express a broader opinion on the economy or specific sectors in the economy.  Now because of the plethora of ETF choices Astor, as well as other asset managers, can be nimbler and more mindful of other opportunities.

Eckstein: As to the economic backdrop, while moderating a bit, it is not exhibiting recessionary indications. Nonetheless, trade wars, the Fed and its interest rate policies and other political issues (domestic and abroad) have created an environment of uncertainty for investors, which the market does not like!

While the economic data gives an assessment of an economy that continues to grow, albeit more slowly than in the past, we know that there will eventually come a time when active managers may get defensive. If/when that happens, bear markets in the broad indices may become more aggressive because of the recent trend toward widespread passive holdings.  My belief is that too many assets are in passive investments that have similar behavior.  To that end, it will magnify the losses if/when the economy is growing below trend or contracting.

We believe the research behind the Astor Economic Index® is so powerful in navigating the market that we’ve made it available to all financial professionals. We are happy to share with advisors our ongoing research and monthly results of our Index’s read on the US economy which is available on the Insights page of our website.

 

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