Positioning for Success in US Exposures: Insights Gained from Machine Learning

• Regardless of whether there is an improvement in market sentiment, one thing is clear. The economic outlook and financial markets could continue to be somewhat nebulous. For this reason, it is important for investors to exercise caution in their portfolio positioning.
• The analysis in this paper, which makes extensive use of machine learning insights, is designed to cater to investors looking for additional ideas in how to implement a regime-based tactical or a strategic asset allocation approach.

In the most recent Global Market Outlook, we highlighted that investors should be vigilant and adopt cautious portfolio positioning in the face of heightened liquidity risk and softening economic growth prospects. Over the last few years, the global economy and financial markets witnessed a tectonic shift from a world of abundant liquidity to one where liquidity was removed at breakneck speed. In our view, the intensity of the inflation surge can, at least in part, be attributed to the rapid increase in money supply in the aftermath of the COVID-19 pandemic. Moving on to 2024, we forecast that growth will slow although a US recession remains a real possibility.

Many of the observations noted in the Global Market Outlook are also confirmed through our textual analysis of the recent Federal Reserve documents — which encompass meeting minutes, press conference transcripts, speeches by Federal Reserve Board of Governors members among others. Unsurprisingly, the topic of inflation continued to take on importance in July 2023.

Based on this analysis, it is also abundantly clear that the way in which the Fed has sought totackle inflation is through the application of monetary policy, rather than any other conventional or ad-hoc measures. Interestingly, our text analysis also suggests that the Fed is now less worried about an imminent risk of inflation, as demonstrated by the reduced mention of the word “inflation” and the generally more positive — albeit still negative — sentiment on the main topics, which are derived from Latent Dirichlet Allocation, a technique frequently used to identify the main topics in texts (see Figure 3). Additionally, the tone relating to “aggregate demand” and “financial markets” has seen the strongest improvement in sentiment.

Regardless of whether there is an improvement in market sentiment, one thing is clear. The economic outlook and financial markets could continue to be somewhat nebulous. For this reason, it is important for investors to exercise caution in their portfolio positioning. The analysis in this paper is designed to cater to investors looking for additional ideas in how to implement a regime-based tactical or a strategic asset allocation strategy.