Human beings are wildly predictable in terms of how they view the future. Simply extrapolate what’s happened in the recent past, build a narrative around why things will continue and keep acting as if nothing has changed or will ever change. But the future is notoriously difficult to anticipate in the long-term. We don’t even really have a grasp of where we are in time. As the old adage goes, most don’t realize they are in a bear market for stocks until after it’s already over. Likewise, most don’t realize that times have changed and a new cycle has emerged until years after it already has.

The passage from Ecclesiastes at the end of this article is, at the core, about cycles. Some seem to be under the impression that markets always need a “catalyst” to do what they do, but cycles often change purely because of time. For years, the cycle we have all been operating in for markets has been characterized by 1) US dominance, 2) pure beta, 3) low volatility, and 4) high volatility of volatility. Any strategy which thrives on risk, has a defensive overlay, or has been active has simply not been able to stand out because of this. Why? Because in an environment where it’s all about US mega-cap stocks, global diversification and international momentum failed. In an environment where it’s all about pure beta, alpha generating strategies failed. In an environment where it’s all about low volatility, tail risk management failed. In an environment where it’s all about high volatility of volatility, active defense to get ahead of down periods failed.

Each one of these dynamics is changing however. US dominance in terms of the S&P 500 being the only place to be appears to have ended, and with good reason. Emerging Markets, which for years have behaved like nothing more than volatile cash, are finally having sticky momentum. With good reason, I might add, given that emerging market sovereign bond spreads are at 3 year lows. Whatever happened to the faux crisis everyone was saying would happen when the Fed raises rates?

As shown in each of our award winning papers (click here to download), nearly all alpha historically doesn’t come from being up more than the market, but by being down less. In periods like the late 1990s and the last few years, the lack of persistent volatility results in an environment where there is no downside to stand out in. That means any active defense ends up looking pointless with hindsight. Historically though, market behavior tends to have many down periods and have plenty of opportunities where one has a chance to not only be down less but also bank that outperformance by having time to rotate offensively.

For this to happen though, one likely needs to see those defense plays (Treasuries and low volatility sectors) to on average underperform high beta stocks in an uptrend for overall market averages. In the last cycle, these defense plays were how to play the upside. For them to revert back to true defense, an internal correction between high beta and low volatility needs to take place. We may be on the verge of that as high beta relative to low vol begins to outperform in what could be a normalization trend.

Whether investors realize it or not, things are changing in significant ways. Few will realize this is happening until years after the trend is firmly entrenched. The why is simple: Investors overwhelmingly shun low past returns, rather than double up for higher ones going forward. Performance chasing rather than cycle recognition tends to be the underlying motivation for why money moves when it comes to markets. Yet, it is cycle recognition which results in the potential to make a lot of money.

“There is a time for everything, and a season for every activity under the heavens: a time to be born and a time to die, a time to plant and a time to uproot, a time to kill and a time to heal, a time to tear down and a time to build, a time to weep and a time to laugh, a time to mourn and a time to dance, a time to scatter stones and a time to gather them, a time to embrace and a time to refrain from embracing, a time to search and a time to give up, a time to keep and a time to throw away, a time to tear and a time to mend, a time to be silent and a time to speak, a time to love and a time to hate, a time for war and a time for peace.” – from Ecclesiastes 3:1-8