Macroeconomic Dashboards for Tactical Asset Allocation

David Clewell, Chris Faulkner-Macdonagh, David Giroux, Sébastien Page and Charles Shriver

JPM 2017, 44 (2) 50-61

doi: https://doi.org/10.3905/jpm.2018.44.2.050
http://jpm.iijournals.com/content/44/2/50
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David Clewell
is a research analyst
at T. Rowe Price
in Baltimore, MD.
david_clewell@troweprice.com
Chris Faulkner-
M acdonagh
is a global portfolio
strategist at T. Rowe Price
in Baltimore, MD.
chris_faulkner-macdonagh@
troweprice.com
David Giroux
is a portfolio manager
and co-chair of the Asset
Allocation Committee
at T. Rowe Price
in Baltimore, MD.
david_giroux@troweprice.com
Sébastien Page
is the head of the multi-
asset division and member
of the management
committee at T. Rowe
Price in Baltimore, MD.
sebastien_page@troweprice.com
Charles Shriver
is a portfolio manager
and co-chair of the Asset
Allocation Committee
at T. Rowe Price
in Baltimore, MD.
charles_shriver@troweprice.com
50    M acroeconomic Dashboards for Tactical Asset A llocation Multi-A sset Special Issue 2018
Macroeconomic Dashboards
for Tactical Asset Allocation
David Clewell, Chris Faulkner-Macdonagh,
David Giroux, Sébastien Page, and Charles Shriver
A
wide body of academic litera-
ture suggests that macro factors
can be significant drivers of asset
returns. And among practitio-
ners, statements such as “stocks make money
in expansions and tend to lose money in
recessions” are often held as self-evident.
However, very little has been published on
how to use these factors to inform invest-
ment decisions. We show how to build
dashboards to help integrate macro factors
into a broader, discretionary tactical asset
allocation process. We view our dashboards
as trade idea generation tools that scour the
entire set of data and highlight possible areas
of excess returns.
Our goal is not to design stand-alone
systematic trading strategies based on
macro factors. Rather, we submit that investors
should use our dashboards to introduce dis-
cipline into their asset allocation process, in
combination with other inputs. For example,
for tactical asset allocation, relative valuations
matter. Even simple strategies that mechani-
cally follow the adage “buy low and sell high”
based on valuation signals—such as the price-
to-earnings ratio—have outperformed static
benchmarks over time.1 However, valuation-
based investment strategies tend to be more
effective when valuations are at extreme
levels. Importantly, strategies that focus solely
on relative valuations can lead to disappointing
outcomes when important macroeconomic
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shifts take place. There’s ample evidence that
macro factors also matter.
PRIOR RESEARCH SHOWS THE
IMPORTANCE OF MACRO FACTORS
Most of the academic literature focuses
on whether macro factors get priced into
markets. Chen et al. [1986] show that the
sensitivities (“macro betas”) of size-sorted
stock portfolios to rates, industrial produc-
tion, inf lation, credit spreads, and consump-
tion explain a significant portion of their
relative performance over time. Fama and
French [1989] use a different methodology
that focuses on the broad stock and bond
markets. They show that business conditions,
as approximated by dividend yields, rates, and
credit spreads, forecast broad market returns.
Several other studies have confirmed the
importance of macro factors in explaining
a wide range of asset class and style premia
returns. Factors covered in the literature
include consumption, unemployment, inf la-
tion, GDP growth, and oil prices. Examples
are highlighted in Exhibit 1.
ISSUES WITH PRACTICAL
APPLICATIONS
While these studies provide credible
evidence of the importance of macro
factors, many practitioners still struggle to
Exhibit 1
Macro Factor Examples in Literature
use these factors for tactical investment decisions at the
6- to 18-month horizon. Economists and investment
teams often operate independently, and the question
of what macro expectations are priced into markets is
often left unanswered. Moreover, the sheer amount of
macro data makes it difficult to separate noise from signal
and anticipate which variables will drive returns.
Another challenge in the practical application of
existing studies is that macro factors may inf luence asset
class returns differently based on initial conditions. Boyd
et al. [2005], for example, show that a rise in unemploy-
ment during an expansion affects stock returns differently
than a rise during a recession. Similarly, the effect of a
decline in industrial production may depend on whether
starting business conditions are good or bad. In fact, we
suggest that any macro factor’s impact on asset returns
depends on the prevailing regime. Yet with the exception
of Boyd et al. [2005], previous research does not account
for the relationship between current conditions and the
subsequent impact of macro factors on asset returns.
PROVIDING DISCIPLINE TO TACTICAL
ASSET ALLOCATION: DATA AND
METHODOLOGY
To map macro factors to expected asset returns, we
propose the use of dashboards. Our approach is different
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from the econometric methods used in academic
studies—it is meant to be simpler and more intuitive.
Also, unlike historical regression analyses based on static
data samples, our dashboards are meant to be dynami-
cally updated so that practitioners can rely on them as
a research tool or to inform investment decisions on an
ongoing basis. We focus on the relative returns between
pairs of asset classes. We highlight which factors may
have a significant impact on which pair trades, under
various scenarios. Importantly, we take into account
current conditions, as ref lected in the macro factors’
current percentile levels.
In Exhibit 2, we show the macro factors included in
our dashboards. This list broadly corresponds to the key
factors documented in previous studies. In Exhibit 3, we
show the list of asset-class-level pair trades that we model
as a function of the macro factors. For each pair trade,
we partition historical asset returns to match a given sce-
nario and current conditions. Our entire framework is
out of sample. Starting from each macro factor’s current
level, our dashboards answer the following question:
If an investor has a one-year view on the direction of
the macro factor, what is the corresponding forward
one-year return?
We illustrate our methodology in Exhibit 4.
To create large enough data samples, we use ranges for
The Journal of Portfolio M anagement    51
Exhibit 2
List of Macro Factors
Notes: All series are retrieved from Haver, except for high-yield spreads
( J.P. Morgan Global High Yield Spread-to-Worst), J.P. Morgan
Emerging Markets Currency Index, DXY (Factset), and U.S.
investment-grade spreads (Bloomberg Barclays U.S. Aggregate Index
OAS). Historical analysis data end in December 2016. All data are
sourced at the monthly frequency. Levels are based on data reported
April 10, 2017. We estimate real yields as the nominal Treasury yield
less year-over-year Core CPI.
the macro factors. We define initial conditions of each
factor, (IC( ft )) as follows:
“low ” x L ≤ f t < x( 25%∗ f )
 they depend on the amount traded, the method of
IC ( f )t = “medium” x( 25%∗ f ) ≤ f t ≤ x(75%∗ f )
 how market impact is parsed from opportunity cost.
“high” x(75%∗ f ) < f t ≤ xU
where ft is the level of the macro factor at time t, and
xL and xU are lower and upper bounds that determine
initial conditions, based on long-term percentile ranks:
x (25%*f  ) is the lowest quartile value of the factor, while
52    M acroeconomic Dashboards for Tactical Asset A llocation Multi-A sset Special Issue 2018
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x (75%*f  ) is the cutoff for the third quartile. Next we define
scenarios (St+1) similarly:
S( f )t +1 = f t +1 − f t (2)
where the scenarios are predefined ranges that are
meaningful to the practitioner (such as a 25 basis point
(bp) rise in 10-year Treasury yields), and the subscript
t + 1 denotes one-year forward returns. Then we calcu-
late the conditional pair trade return (RtC+1) as
RtC+1 = E( Rt +1 IC t , St +1 ), (3)
which is the average historical return of the pair trade
when initial conditions were in the same range (low,
medium, or high), and the factor subsequently moved
according to the scenario. We also include the 10th to
90th percentile range and identify when the sign was the
same as the average (“hit rate”) at least 80% of the time.
For example, suppose we want to evaluate the
impact of the dollar on the relative performance
between small and large cap stocks. Over the entire
sample, from January 1990 to December 2016, U.S.
small caps (Russell 2000) outperformed U.S. large caps
(Russell 1000) in 51% of rolling 12-month periods. For
monthly data available through April 10, 2017, the U.S.
dollar index stands at 100.6, which is in the top quar-
tile of its history since January 1990. Further, suppose a
tactical asset allocator expects the U.S. dollar to rise fur-
ther. Given history, when the U.S. dollar was in the top
quartile and subsequently rose by 5% (or more) over the
next year, U.S. small caps outperformed U.S. large caps
88% of the time. The average outperformance was 8.2%,
with the 10th to 90th percentile range between -2.3%
and 15.9%. In this case, the outperformance of U.S. small
caps in periods of rising USD may be attributed to their
lower reliance on exports, compared to U.S. large caps.
Transaction costs are difficult to estimate because
execution (physicals versus futures, for example), and
(1)
Nonetheless, for illustration purposes, we report returns
net of a rough estimate of transaction costs, which are
detailed in the appendix.
In Exhibit 5, we show how to read the dashboard,
and in Exhibits 6–9, we show the dashboards under uncon-
ditional, stable, rising, and declining macro factors.
Exhibit 3
Asset Class Returns

Notes: Historical analysis data end in December 2016. Unless specifically identified, asset class returns are computed using total return indices. All data
are sourced monthly. The T. Rowe Price Real Assets Blended Benchmark is the following: As of December 1, 2013, the Real Assets Combined Index
Portfolio comprises 25% MSCI ACWI Metals & Mining, 20% Wilshire RESI, 20% FTSE EPRA/NAREIT Dev Real Estate Index, 19.5%
MSCI ACWI Energy, 10.5% MSCI ACWI Materials, 4% MSCI ACWI IMI Gold, and 1.00% MSCI ACWI IMI Precious Metals and Minerals.
Prior to this date, the Real Assets Combined Index Portfolio was composed of 25% MSCI ACWI Metals & Mining, 20% Wilshire RESI, 20% FTSE
EPRA/NAREIT Dev Real Estate Index, 16.25% MSCI ACWI Energy, 8.75% MSCI ACWI Materials, 5% UBS World Infrastructure and
Utilities Index, 4% MSCI ACWI IMI Gold, and 1.00% MSCI ACWI IMI Precious Metals and Minerals.
Sources: Bloomberg Barclays, Russell, Credit Suisse, FactSet, J.P. Morgan, and T. Rowe Price.

The average return reported under “Conditional
Returns” of the first dashboard (Exhibit 5) is weighted
based on bucket size (percentile range) for each macro
factor. The P-value indicates whether this average
return—from current starting conditions (as of April 10,
2017)—is statistically different from the full history of
returns; it should be below 0.05 (or 95% confidence
level) to indicate a meaningful difference.
Interpreting the Dashboards
As shown in Exhibit 6, all else being equal, based
on current conditions with no forward view, macro
factors are unlikely to drive relative asset class returns
(over the next year) to be different from long-term
“unconditional” returns. However, as shown in the
scenario-specific dashboards (Exhibits 7–9), the direc-
tion of the macro factors over the next year could matter.
Stable or improving macro conditions correlate
with strong returns for “risk-on” trades, such as long
stocks, small caps, high-yield bonds, and emerging
market bonds. On the other hand, a rising U.S. unem-
ployment rate, especially from its currently low level, is
likely to be connected with a selloff in stocks.
Emerging market currencies may be an important
factor to watch. Stable or rising emerging market
currencies are supportive of emerging market equities,
real asset equities, and emerging market bonds.
Further, emerging market currencies have depreciated
significantly—the index currently sits at the bottom 5%
of its historical range. If they move significantly up or
down from their currently low level, they could corre-
late with meaningful directional volatility across assets.

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Exhibit 4
Stylized Illustration of our Out-of-Sample Methodology
And the price of oil, if it remains stable or appreci-
ates from its currently medium level (63rd percentile),
could be a significant positive driver of emerging market
stocks, real asset equities, and emerging market bonds.
Regarding style rotation, growth stocks have longer
duration than value stocks. Therefore, even though value
stocks have a higher dividend yield than growth stocks,
when rates decline, growth outperforms; and when rates
rise, value outperforms. This effect occurs both in the
United States and EAFE markets. The large weight of
negative-duration financials in the value index partly
explains this effect.
There are several other useful interpretations of
the data, but in general, our results are in line with
economic intuition, as well as the findings published
in the literature we reviewed. The contribution of our
54    M acroeconomic Dashboards for Tactical Asset A llocation Multi-A sset Special Issue 2018
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dashboards lies not in their academic merit, but rather in
their value to practitioners. The confidence intervals and
hit rates help filter the continuous f lood of macro data.
(Note that we do not report volatilities by pair, but they
are directly proportional to the confidence intervals.)
Importantly, although the relationships among the
macro factors and asset classes are reasonably persistent,
the dashboards should be updated frequently, because as
initial conditions change, some of the investment con-
clusions may change as well.
CAVEATS
We don’t claim to identify causation, which is
almost always impossible to determine given the com-
plexity and dynamic nature of which factors drive asset
Exhibit 5
How to Read the Dashboards
returns; rather, we merely identify correlations that appear
meaningful and leave it to the investor to assess causation.
Also, although the academic literature suggests
that our selected macro factors can be significant drivers
of asset returns, the confidence intervals for one-year
returns in our dashboards are wide, and statistical
confidence is low across the board. Hence, we don’t
recommend building systematic tactical asset alloca-
tion strategies based solely on these macro data and in
this manner.
Instead, macro data should be used in combi-
nation with relative valuations and other factors such
as fundamentals and technicals to determine both
whether to invest, and in what size. Macro factors are
often used to confirm relative valuation signals. For
example, if ACWI ex-U.S. equities are cheap relative
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to U.S. equities based on valuation metrics (price-to-
earnings ratios and other such metrics) and macro fac-
tors indicate ACWI ex-U.S. should outperform, then
a tactical asset allocator may take a larger position in
ACWI ex-U.S. equities than if valuation and macro
data don’t agree.
Another caveat is that we don’t model expecta-
tions directly. In theory, we should run our scenarios
against the expectations that are priced into the market.
The problem is that expectations are often difficult and
in many cases impossible to measure. Survey data may
be useful, but they rarely reveal what markets are truly
pricing in, nor are survey results available on a timely—or
broad enough—fashion going far enough back in time.
Regarding market-implied views, forward curves incor-
porate a risk premium, which makes it hard to disentangle
The Journal of Portfolio M anagement    55
 Exhibit 6
Dashboard of One-Year Forward Returns Based on Current Macro Conditions, April 10, 2017

56    M acroeconomic Dashboards for Tactical Asset A llocation

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The P-value associated with (C) ≠ (A) is generally between 0.9 and 1.0 given current economic factors. This means the current average and distribution is not statistically different fom the
long-term averages.

Multi-A sset Special Issue 2018

 Dashboard of One-Year Forward Returns Based on Current Macro Conditions, Assuming Stable Factors, April 10, 2017
Exhibit 7

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 Dashboard of One-Year Forward Returns Based on Current Macro Conditions, Assuming Rising Factors, April 10, 2017
Exhibit 8

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 Dashboard of One-Year Forward Returns Based on Current Macro Conditions, Assuming Declining Factors, April 10, 2017
Exhibit 9

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an expectations component. Ultimately, Chen, Roll, and A pp e n d i x
Ross [1986] mention that spreads and interest rates series
are noisy enough to be treated as unanticipated. Also, Transaction cost assumptions are for illustrative
they find that econometric methods to extract the unan- purposes. Actual transaction costs may vary.
ticipated component of industrial production do not offer
any advantage over the unadjusted series.2
Lastly, we’ve selected easily investable asset class
pairs. This list represents asset classes commonly used
in practice by asset allocators. But in theory, it would
be more elegant to isolate market factors and scale posi-
tions based on volatility. For example, we could hedge
the equity risk factor common on both sides of the
small- versus large-caps pair, or at least make sure the
trade is equity-beta neutral. Although statistical sig-
nificance would likely increase (see Naik et al. [2016]),
we would move away from implementable trades. Ulti-
mately, our goal is to add discipline to the analysis of
macro factors, and our framework is one piece of the
puzzle, focused on idea generation. Portfolio construc-
tion then involves combining macro with other fac-
tors, adjusting broad market factor exposures, as well
as risk-scaling positions between the long and the short
leg and across trades.

CONCLUSIONS

Too often, quantitative models ignore the cur-

rent state of the world. Historical data analysis can be
useful (after all, we don’t have future data), but only to
the extent it helps formulate a view about the future.
Our dashboards help practitioners filter historical data
to try to predict the impact of macro factors on asset
returns. Based on a wide body of academic literature,
we have developed a framework that incorporates cur-
rent conditions and that investors can easily replicate.
Instead of empirical statistical tests on the pricing of
macro factors—which have already been covered in
prior academic research—we focus on how to use data
in the investment decision-making process. Our dash-
boards filter one-year forward returns for a wide range
of asset-class-level pair trades, based on current macro
conditions and expected movements in macro factors.
Our results reveal that for tactical asset allocation, macro
factors matter.
ENDNOTES
The authors would like to thank Stefan Hubrich, Ph.D.,
CFA, Sean McWilliams, the T. Rowe Price Multi-Asset
Research and Development team, the T. Rowe Price Asset
Allocation Committee, Josh Yocum, CFA, and Natalie Reed
for their support and feedback to improve the framework and
sharpen the usefulness of the research for investors across the
firm.
1
See, for example, Chapter 5 in Naik et al. [2016], as
well as the performance of the stand-alone value strategies
in Blitz and P. Van Vliet [2008], Asness et al. [2013], and
Haghani and Dewey [2016].
2
However, they lead industrial production by one year.
For tactical asset allocation, this obviously would be like
“cheating” because it would assume perfect foresight.

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The Journal of Portfolio M anagement    61