(Bloomberg) -- The nightmare for investors in both stocks and bonds took a turn for the worse this week as the Federal Reserve shocked markets by lifting their projections for interest-rate hikes while simultaneously lowering their outlook for economic growth.
So is there anything that’s actually working in this type of environment? George Patterson, chief investment officer of PGIM Quantitative Solutions, joined the “What Goes Up” podcast to discuss some quant strategies that have held up amid the market selloff. Below are condensed and lightly edited highlights of the conversation. Click here to listen to the full podcast, or subscribe on Apple Podcasts or wherever you listen.
Q: We’ve noted that trend-following strategies have fared well in a year when little else has worked. What else is a solution from a quant perspective for a challenging environment like this? What are you telling those clients looking to either get some kind of return this year or at least protect the wealth they have?
A: We do have several offerings that focus on trend-following or global macro strategies or tail hedging. Those have been very successful. This is the perfect economic environment where you do have big movements, as well as some big inconsistencies across the globe. For example, looking at Japan and how everyone else is raising rates and Japan is really not. However, there’s a couple of other things. One is commodities and the other would be real assets in general. Maybe the last one I would talk about would be some downside protection.
So commodities and real assets, we’ve seen a big run-up in commodities and a bit of a retracement. But over the long run, there’s a lot of research that shows that commodities do very well in this type of environment. Our view is that the Fed is going to be successful in taming inflation, but it’s also going to take a little bit of time. It’s not going to come down very rapidly. And we think there’s a lot of opportunities for commodities in a portfolio. So that’s one area. Real assets, whether it’s real estate or other direct real investments, also typically do very well in inflationary times.
The other thing that we have a lot of conversations about is downside protection. How do you build a strategy that can either hedge tail risk, or just deliver most of the upside while limiting the downside? And again, there’s a number of different solutions we offer in that area. So those I’d say are the main subjects that we’ve been talking about to clients that we’ve seen the most interest in.
Q: What do you expect from the Fed for the remainder of the year?
A: Over the summer, with some earlier statements from Powell, he tried to portray a very serious view about taming inflation, and he came away saying that, “We’re going to do it.” But he was maybe just a little bit too dovish. And we saw a very large rally in markets over the summer as the result of that, even though a number of other Fed speakers came out and really were much more pessimistic about things. So really since then, what we’ve seen is he has just had to be extremely clear that they are going to get their job done and it is going to cause some disruption. Some of his earlier statements, he was trying to be a bit more balanced. But I think now, given the market’s reaction, he has just realized that he has to be extremely clear about where he thinks things are going.
Now, don’t forget it, it is a challenging economic outlook, but it follows several years of huge gains in the market. If you look over a longer period of time, we’ve had a lot of gains in a short period of time. So it’s not unrealistic to expect a little bit of give-back in the next year or two.
Q: I know natural-language processing is something you’re very interested in. Jerome Powell and the Fed’s message seemed pretty clear. But is there something more that a computer program can glean from a Fed statement and press conference like we got this week?
A: There’s several things that I would say are relevant. I’m sure there’s a lot of people out there that are running very short-horizon strategies, looking at what words he chooses to use and specifically the questions and answers that come out of that, and are looking to get in or out of the market very quickly to take advantage of a short-term movement. The real advantage, however, of language processing is just that you can go in-depth. You can read a 10-K and analyze a lot of aspects of it, and you could do that for two or three of them, but it could easily take you half a day or a day each. The advantage of language processing is that you get the breadth. So you can do 3,000 of these in a matter of minutes or maybe half an hour, depending on what type of models you’re running. But it’s a combination of the breadth and the timeliness, I would say, that makes it relevant.
And if you think about humans, so much of our intelligence, so much of our knowledge is really encoded in writing. We’ve been collecting numerical data for some time, but people have been generating written texts since the beginning of putting text down on paper. So there’s just a huge amount of information that comes out and there’s a lot of value in there, is what we have found. So it’s been one of the most-relevant areas for us over the past few years to extract information.
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