This is a note from Prometheus Institutional.
Every day at midday, we share updates to our US Macro Regime Probabilities with Prometheus Institutional, along with our synthesis of what the current regime probabilities suggest.
Our Macro Regime Probabilities use our bottom-up signals across asset markets to construct forward-looking estimates for the cross-asset macro market regime. These signals incorporate both fundamental and price-based information to produce high-frequency, forward-looking estimates for the US cross-asset environment. These signals are best used as a forward-looking guide for the cross-sectional returns across macroeconomic assets. We define the regimes as follows:
(+) G (-) I: Rising Growth & Falling Inflation, Equities Outperform
(+) G (+) I: Rising Growth & Rising Inflation, Commodities Outperform
(-) G (-) I: Falling Growth & Falling Inflation, Treasuries Outperform
(-) G (+) I: Falling Growth & Rising Inflation, TIPs Outperform
Synthesis: Our Macro Regime Probabilities show a flattening of the distribution of potential economic outcomes. This dynamic is flattening the distribution of regime-expected returns.
A relatively flat distribution of regime-expected returns supports holding a diversified mix of global assets. We find a diversified mix of global assets to be attractive, with our expected return program showing all asset classes offering reasonable expected returns:
Furthermore, the diversification benefits of owning a portfolio of assets remain significant versus history. The mean return of holding any given asset class today offers a Sharpe Ratio of 0.51. However, combining assets into a portfolio aligned with the Prometheus Expected Return Program yields a portfolio-level expected Sharpe Ratio of 1.13:
This elevated return-on-risk level comes with increasing de-correlation across assets. We visualize this using the effective number of bets in a portfolio of global assets:
With the distribution of regime expected returns flattening, we think it best to consider the adage: When in doubt, diversify.
Until next time.
A flattening regime distribution is a clean argument for diversification, but it undersells how much disagreement still sits underneath the surface.
Private Equity carries both the highest expected return in the CMA set, 9.65%, and the widest standard deviation, 2.2, and that return figure is already trending down quarter over quarter.
Diversification works precisely because that kind of disagreement exists, not despite it.