Aahan Menon: Impulses Driving Risk Appetite are Likely Transitory

Listen on The Move

Aahan Menon joined us to discuss Prometheus Research's investment framework, which is based on economic forecasting of growth, inflation, and liquidity. He emphasized the importance of market regime confirmation to mitigate the risk of being wrong in economic forecasting.

We discussed the challenges of accurately forecasting economic conditions and the impact of liquidity on the economy and asset prices. Aahan shared his investment framework, which is based on economic forecasting of growth, inflation, and liquidity, and the importance of market regime confirmation to mitigate the risk of being wrong in economic forecasting.

We delved into the potential for a recessionary contraction in the economy and the impact of a tightening labor market on employment and economic activity. Aahan also shared Prometheus Research's current forecast, which predicts a growth contraction of between negative one and negative two percent over the next six months, with an economy-wide inflation print of about five percent.

Aahan notes, there is an unreasonably large gap between institutions and individuals when it comes to macro, and Prometheus aims to close that gap.

As Aahan says, "The goal is to understand those state changes in the trend and estimate when they will occur, which will force a rerating of expectations." So, this episode is a terrific look into wading through and navigating the most relevant macroeconomic cycles and data, how Prometheus Research approaches this systematically, and the end product, which is a model ETF portfolio; Be sure to give this episode a listen if you're interested at all in ways to outsource some of your macro-economic and macro-market distillation.

One takeaway insight: "The traditional cyclical indicators of the economy, such as durable goods and manufacturing, are becoming less significant due to the shift towards a services-oriented economy." - Aahan Menon


Unique approach of Prometheus Research [00:03:27] Aahan explains how Prometheus Research provides real-time insights into the evolution of markets and the economy through a data-driven, rules-based process, and how they aim to help investors of all sizes navigate macroeconomic cycles.

Navigating the tension between market and macroeconomic modeling [00:06:31] Discussion on how to navigate the tension between the market's forward-looking discounting mechanism and the utility of macroeconomic series.

Opportunity set in macro investing [00:07:48] Explanation of how understanding the likely gap between a potential acceleration and what's discounted in terms of a linear path is the opportunity set in macro investing.

Variant perception and difficulty in determining market expectations [00:10:15] Discussion on variant perception and the difficulty in determining what the market is currently discounting compared to forecasting the first or second derivative of economic variables.

Data used in modeling [00:13:52] Discussion on the types of data used in forecasting conditions and how they are obtained.

Macroeconomic Model

Output of the forecasting process [00:17:28] Discussion on the end product of the forecasting process and the current forecast for growth and inflation.

Factors driving the forecast [00:19:33] Discussion on the factors driving the current forecast, including monetary tightening and debt service burdens.

Housing activity and employment contraction [00:20:45] Discussion on the contractionary condition of the economy, the impact on the housing sector, and the potential for a recessionary condition.

Construction employment and cyclical industries [00:23:06] The relationship between construction employment and cyclical industries, and how they account for almost 100% of the variation in employment during economic downturns.

Softening of the labor market [00:26:34] The potential for a recessionary contraction despite historically low unemployment rates, and the projection of sub 2% unemployment rate by the end of the year.

Unemployment and its impact [00:28:10] Discussion on the impact of unemployment on the economy and how it can lead to a downturn.

January's data [00:30:39] Analysis of the January data on employment, retail sales, and inflation, and how it was driven by a rise in employment in the professional and business services sector.

Impact of employment on spending [00:32:08] Explanation of how the rise in employment in one sector led to an increase in nominal spending in other sectors, supporting retail sales and consumption data.

Employment and Inflation [00:34:25] Discussion on the recent pulse in employment and its impact on inflation, as well as the unlikelihood of it continuing in the future.

Productivity and Economic Growth [00:37:42] Mention of a recent McKinsey paper on the potential impact of productivity increases on inflation and debt, and how it could affect economic growth.

Unemployment Rates and Employment Growth [00:36:38] Exploration of the relationship between unemployment rates and employment growth, and the unlikelihood of unemployment rates staying flat without a slowdown in employment growth.

Retirements and Wealth [00:40:46] Discussion on the excess retirements due to windfalls and wealth, especially in housing, and the possibility of retirees returning to work.

Labor Force and Profits [00:43:46] Analysis of the impact of labor force participation and employment growth on the economy, and the squeeze on profits due to businesses' own reinvestment.

Fed and Inflation [00:46:12] The likelihood of the Fed catalyzing a recession to reign in inflation expectations, and the uncertainty around how high and for how long rates will be raised.

Economic impact of interest payments [00:47:43] Discussion on the impact of interest payments on inflation and the economy.

Recomposition of the economy [00:51:04] Explanation of the shift towards a services-oriented economy and the impact of income injection on the economy.

Actionable Investing Guidance

Navigating the cycle [00:53:02] Discussion on navigating the cycle and the relative strength of cyclical sectors.

Investment decisions [00:53:46] Explanation of how Prometheus Research's algorithmic work informs investment decisions.

Investment Framework [00:54:22] Aahan explains the economic forecasting framework used by Prometheus Research, focusing on growth, inflation, and liquidity. They also discuss the challenges of forecasting and the importance of market regime confirmation.

Portfolio Construction [00:56:02] Aahan discusses the timing tools used by Prometheus Research to create stable return streams that are impervious to any particular regime or auto-correlation structure. They also talk about the importance of managing volatility and risk in the current tightening liquidity environment.

Current Positioning [00:57:57] Aahan shares Prometheus Research's current positioning, which includes a high level of cash and a focus on relative value trades such as being long the dollar and long T-bills. They also discuss potential trades, such as shorting the two-year and being long bonds.

Employing Macro Indicators [01:00:04] Discussion on the challenges of employing macroeconomic indicators and deriving signals from them as their relative importance changes based on compositional changes.

Liquidity Picture [01:01:30] Importance of liquidity picture in having a broad lead indicator approach that is different from the growth indicator approach.

Recalibrating Indicator Weights [01:03:54] Concept of recalibrating indicator weights over time based on long-term moving average of their beta to the underlying things being forecasted.

Dynamic Investment Portfolio [01:06:00] The investment portfolio is never touched and decisions are made dynamically based on the output of economic modeling.

Liquidity and Asset Pricing [01:07:27] Discussion on the role of liquidity in asset pricing, the impact of the Fed's balance sheet on liquidity, and the future of liquidity as a variable in macro models.

Liquidity Concerns

Understanding Liquidity [01:09:53] Explanation of Prometheus Research's approach to tracking liquidity, the hierarchy of liquidity, and the role of the government and private sector in providing liquidity.

Liquidity Management [01:13:36] Discussion on the evolution of liquidity management and its impact on interest rates and maturity transformation.

Impact of Balance Sheet Size [01:14:59] Exploration of the impact of the size of the Fed and government balance sheets on the economy and financial markets.

Composition of Treasury and Fed Balance Sheets [01:16:06] Analysis of the beta of changes in the composition and tenure of the Treasury and Fed balance sheets on the economy and asset prices.

Term Structure Dynamics [01:17:01] Discussion on the impact of the Fed's manipulation of the term structure on asset prices and risk premia.

Combined Picture of Policy and Private Sector Liquidity [01:19:49] Importance of tracking the combined aggregate of policy and private sector liquidity using both issuance and interest rates to explain the variation over time.

Private sector credit creation and liquidity [01:20:42] Discussion on the impact of private sector credit creation and liquidity on the economy and financial markets.

Improvement in banking and corporate activity [01:22:16] Analysis of the improvement in lending and issuance of commercial paper, high yield, and IG in 2022.

Factors affecting liquidity creation [01:24:00] Explanation of the rush to issue commercial paper in anticipation of rate increases and the impact of nominal activity and inflation on liquidity creation.

Pro-cyclical liquidity and economic activity [01:25:04] Discussion on the likelihood of pro-cyclical liquidity continuing and the impact on economic activity, as well as the potential effects of quantitative tightening and responsible treasury policies.


Where to find Aahan Menon:

Prometheus Research Substack

Where to find the RYA crew:

Adam Butler on Linkedin

Pierre Daillie on Linkedin

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