The Performance Cycle

Performance cycles not only work at all time degrees but also challenge the idea of hedging.
We were the first ever in the world to talk about long India and short China on 21 Feb 2009. We were also the first to publish long Nikkei-short BVSP Brazil, long Russia – short Nikkei, long India – short Nikkei and long Nikkei – short China in a paper on performance cycles co-authored by Ionut Nistor and me, published in the Kyoto University Journal in Mar 2009. We gave two time frames for pair performance. One was multiple months and one performance cycle extended for years till 2013-2015. We also said that the Goldman BRIC Model was broken if BRIC country performance with the Japanese region was polarized. All the pairs registered gains and were up 27% (long Nikkei, short BVSP Brazil), up 14% (long Russia, short Nikkei), up 51% (long India Sensex, short Nikkei), up 59% (long Nikkei, short Shanghai composite). We have enclosed the paper as a weblink here. The.BRIC.Model.100209
It was kind of shocking both for the academicians and for the capital market participants. A few even thought of such work as unworkable strategies. These were a few remarks posted below the article in business standard.
Suki – “How would you rate the Precision high quality engineering skills in India vs that of China? Who is going to be the better supplier of precision products in the future? Are Indians less quality conscious than China, overall and specifically in industry?”
Nano – “will there be a market for Tata’s Nano, or it will ever be successful to compete against the Japanese or Korean car models? Where will India find enough resource to feed its growing population in the future? Yahoo, oracle, IBM, Cisco and other American software companies will out of business soon, where will India be as software subcontractor? The fact speaks to itself; India can’t build anything that is useful, not even toys! Money is a king at this difficult economic time, and china has more than 1.3 trillion US dollars reserve and India has basically none. The author of this article does not understand economic issue. Chinese consumer market is much bigger than India.”
Keith – “I don’t know what it is about Indians that they enjoy putting down China so much. For China’s point of view, India isn’t worth making comparisons with. You never see many if any Chinese making these pointless comparisons. We just don’t care if Indians have to go to work in their software houses riding on mules on cracked roads, nor would we care if they went to work in Rolls Royce’s on roads paved in gold.”
John – “The Chinese has observed that while South Korea like to over-glorify their past, India has a tendency to over-glorify their future. How long have you been talking about the great India-surpass-China miracle? Where was that “21st century belongs to India”? Talking about a great future does not bring a great future, no matter which “model” you used in your predictions. Instead of spending years writing papers on how India will triumph in the future, why don’t you guys spend a few minutes thinking about how to make India work, today.”
Mark – “Sorry, with all the capitals running out of India, I don’t see infrastructures being belt with bare hands. Short India, short China, long USA.”
We tried explaining that performance cycles work in both directions in favor and against China. This is what we said “Performance cycles are mathematical. The comparison is quantitative, which can have qualitative reasons. A few years back, it was long China – short India. The qualitative reasons could have been different in that case. If population and consumption was key, there would have been no east-west dominance cycles. East was historically more populated then the west. Consumption is a creation of modern economics. Population and consumption or anything else cannot change performance cyclicality. Any small country with 1/100 the population of CHINA can outperform CHINA in percentage terms for a certain period.”
The idea of a preordained cyclicality of performance working in markets challenges many economic think tanks dedicated to researching and forecasting the same. Performance cycles based on time fractals simplifies too much for the linear time generation of researchers to accept. Our idea is still not about dissuading researchers from conventional research but embracing something so repetitive and structured as time fractals also know as time cycles. The cyclicality in markets between regional indices is a new thought even for macro funds playing between regions. How many funds do you know doing pair trading strategies between Japan and the BRIC countries? And how many investors do you know putting money in such funds? Even if there are funds doing this there is still little credit given to time and its cyclicality.
There is another reason why the idea escapes the majority. The one who understand performance also consider it as just one cycle not two, three or many. Human mind is predisposed to linearity. This is why psychologists call humans as shortsighted. There was no way behaviorologists would have called us myopic, if we could see cycles. Our inability to see cycles is at the core of behavioral finance and psychological errors. We see only one up part of the cycle not two. We comprehend performance more than underperformance. We buy winners and sell losers. If we would have comprehended that today’s losers are tomorrow’s winners, we may be selling winners and buying losers. Above this we rarely look at both winners and losers together. For the majority today performance is secular not cyclical. This is why investors fail to comprehend how long India – Short China and Short China – Long India can make money. For example HDFC BANK and ICICI BANK pair. One may believe HDFC BANK to be a sector leader a notch ahead of ICICI BANK. With this information in the background a strategy of short HDFC – long ICICI BANK may be ridiculous. How can be buy and sell two highly correlated assets? We assume statistical correlation above time. We don’t realize that correlation like everything else is cyclical and changes with time. Take two time series and compare them over multiple time frames and you will see differing correlation values. Beta, the highly touted hedge ratio suffers from the same problem. Take beta values for various time frames on two data series and you will see fluctuating values. Majority of our investment problems do exist because we don’t want to admit cyclicality, which exists everywhere and at all levels of time.
The over discussed long India and short China pair can validate this. The pair made 55% since we mentioned about it early this year. The maximum return that could have been captured between the two indices was 60% in 173 calendar days during 09 Mar 2009 – 31 may 2009. One had to invert the pair from 31 may 2009 till 12 July 2009 for 90 days Shanghai composite outperformed BSE SENSEX by 21%. From 12 July to 30 Aug, it was long India and short China again for 48 days delivering 22%. This was a classic example how Chinese and Indian performance was shifting in a cycle from one to the other. We can illustrate this same performance cycle on larger time. 31 July 1994 till 03 Jun 2001 (seven years) China outperformed India by 100% (annualized 14%). 03 June 2001 till 31 mar 2006 the performance cycle shifted (five years) in favor of India which outperformed china by 279% (Annualized 55%). We can go to a weekly cycle or daily performance cycle and show the same shifting performance cycles between the two regions. Performance is cyclical and predictable.
Performance cycles challenge the idea of a hedge like nothing else. We talked about it briefly in our India H2 2009 outlook. Any pair which delivers 20-30% annualized returns is an opportunity to invest and not to hedge. If strange sounding pairs between regions can deliver such returns, a hedging exercise built around avoiding a loss or gain is counterintuitive. No wonder hedging is a cumbersome exercise when not based above the underlying cycle. We also have beta tracking techniques, which is constant adjusting of two legs to keep them of similar value. We calculated the BETA of the BRIC country indices and Japan with the MSCI world index. Nikkei and Bovespa had the closest betas compared to the world index. Close betas warranted a value hedging and not beta hedging. This means that the Nikkei – Brazil pair also delivered 18% annualized. Performance cycles make a strong case against conventional hedging. This is no surprise. Hedging without an understanding of Time fractals is an illusion.